India's inflation target band up for review: FM Nirmala Sitharaman

CPI inflation was back within the MPC’s range of 4 (+/-2) per cent since December 2020, and fell to a 16-month low of 4.06 per cent in January
India’s inflation target band of 2-6 per cent is up for review as the five-year term for the Monetary Policy Committee’s (MPC’s) inflation-targeting framework draws to a close, Finance Minister Nirmala Sitharaman said on Thursday. “The MPC’s term is coming to an end. Inflation targeting will also have to be reviewed. We shall do that,” Sitharaman was quoted as saying by Reuters.

The government has asked the Reserve Bank of India (RBI) for its views on the targeting framework, said a senior government official. The government has also sought the central bank’s suggestion on tweaks to the CPI basket and if the old weightings need to be changed or recalibrated, said the official. The new framework would be announced by March 31, he added.

The framework, notified in 2016, mandates it to target 4 per cent consumer price index (CPI) inflation until March 31, 2021, with the upper and lower tolerance limits of 6 per cent and 2 per cent, respectively. 

The RBI Act was amended to provide for the inflation target to be set by the central government, in consultation with the RBI, once every five years.

The current range of 2-6 per cent is valid till the end of this fiscal year. The CPI-based inflation rate did not come down below 6 per cent till November in the last calendar year, barring March.

According to the RBI Act, amended through the Finance Act, 2016, the central bank has to send a report to the government in the case of a breach in the mandate cited above, stating reasons for failure to achieve the target, remedial actions proposed to be taken by it, and an estimate of the period within which the inflation target will be achieved.

However, the MPC has not taken the April and May inflation numbers into consideration because these were imputed, escaping government scrutiny.

CPI inflation was back within the MPC’s range of 4 (+/-2) per cent since December 2020, and fell to a 16-month low of 4.06 per cent in January, after hovering above the upper limit of 6 per cent of the target since March 2020.

However, the government and the RBI are of the view that the current targeting framework has worked out well and the status quo must be maintained. After the recent monetary policy announcement, RBI Governor Shaktikanta Das said that inflation targeting had worked well.

“The experience with successfully maintaining price stability and the gains in credibility for monetary policy since the institution of the inflation targeting framework, barring the Covid-19 period, need to be reinforced in the coming years even as we exit the pandemic and seek to exploit the opportunities of the post-Covid world,” he had said.

Recently, Das had also said a wider band for targeting inflation would be meaningless because it would dilute its effectiveness in setting monetary policy.

In a working paper released by the RBI in December, authors Deputy Governor Michael Patra and Harendra Kumar Behera had also defended maintaining inflation target at 4 per cent in the medium term. 

“If it ain’t broke, don’t fix it,” it had said.

The government has echoed this view, and has favoured maintaining the status quo for targeting inflation. In a recent interview with Business Standard, Prin­cipal Economic Adviser Sanjeev Sanyal had said the current system had worked reasonably well to bring down inflation.

“I don’t think there is any need to tinker with it too much. Also, it’s a reasonable range of 2-6 per cent and we have very rarely gone outside it,” he had said. The CPI basket can be updated, and the exercise is periodically done by the government and the RBI, Sanyal had said.

However, Madan Sabnavis, chief economist at CARE Ratings, said India conventionally had had high inflation, and the MPC’s inflation target should be increased to 5 (+/-2) per cent. “Ever since the MPC was constituted, we have seen low CPI inflation, but historically, it has been above 5 per cent. Targeting 4 (+/-2) per cent is not reasonable,” Sabnavis said.

The MPC has deviated from the inflation target last year due to the pandemic, and the government should address the question whether growth should be targeted along with inflation, Sabnavis said. Another important argument, Sabnavis said, is whether CPI inflation was the better index to be targeted, given the fact that food prices were volatile. The government must explore if WPI inflation can be made an anchor, he said. “If the WPI is chosen to be the right index, then the target cannot be 5 per cent,” he said. To exclude the impact of high, volatile food prices, the MPC can also be mandated to target core inflation, he said.

Core inflation is calculated after taking out food and fuel items.

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