MPC Meet: Existential Questions For RBI And India’s Monetary Policy Committee

The final issue, and perhaps the most tangible one of the three, is the inflation target.

For the past two months, retail inflation has been above 6%. That’s the upper bound of the 4 (+/-2)% flexible inflation target. The RBI hopes it will fall to below 6% and average 5.2% in FY22.

That still remains well above the 4% mid-point. Recall here that it took a fairly lengthy battle to establish the need to bring inflation down to 4%. While many had opposed it, the camp of inflation targetters had eventually won and hence the target had been defined around the mid-point of 4% as opposed to just 2-6%. Implicit in the framing of that target is the need to move toward the mid-point of 4% inflation, eventually and over the medium term.

But for 21 months now, inflation has stayed above 4%, pointed out Pranjul Bhandari, chief India economist at HSBC in a note this week. “Several inflation drivers have come and gone. But inflation has stayed elevated, like a chameleon, adapting itself rather quickly to the driver of the day.”

To date, there are supporters and detractors to the 4% target.

Ahead of a review of that target earlier this year, the RBI’s research division had backed it, saying that trend inflation has fallen to a range of 3.8–4.3% during the period of flexible inflation targeting, indicating that 4% is the appropriate level of the inflation target for India. “Threshold inflation above which growth is unambiguously impaired ranges between 5 and 6% in India, indicating that an inflation rate of 6% is the appropriate upper tolerance limit for the inflation target.”

A counter-point had come from former MPC member Ravindra Dholakia. A paper he co-authored with Jai Chander, Ipsita Padhi and Bhanu Pratap, had pegged the threshold level of inflation at closer to 6% and optimal growth at 7.5%. “If we consider the inflation target at 4% instead of the threshold level of 6%, the long-term growth rate would decline by about 80 basis points,” the study had said.

That debate not withstanding, 4 (+/-2)% is the legal mandate. As the Covid crisis ebbs, will the MPC seek to reinforce the need to bring inflation closer to the mid-point of that target?

Some members may see the need to do that. “The MPC has been able to maintain monetary accommodation in the face of above-target inflation mainly because of its hard-earned credibility for successful inflation targeting. To maintain and enhance this credibility, the MPC needs to remain data driven so that it can respond rapidly and adequately to any unforeseen shocks that may arise in future,” said JR Varma in the last set of minutes. The statement that may prove prescient in the coming months if inflation prevails.

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