RBI in favour of retaining inflation target for 5 years

MUMBAI: The Reserve Bank of India (RBI) said on Friday it is in favour of retaining the existing inflation target set in 2016 for the next five years, ahead of an upcoming government review.

Under India’s flexible inflation targeting (FIT) approach, the central bank is expected to work to maintain retail inflation at 4%, with an upper tolerance limit of 6% and a lower limit of 2%. The six-member monetary policy committee (MPC) headed by RBI governor decides on policy rates keeping this target in mind.

Mint reported on January 28 that the government may reset the rate at 5% to provide the central bank more leeway to cut policy rates and support growth in the pandemic-struck economy. “The current numerical framework for defining price stability, i.e., an inflation target of 4% with a +/-2 per cent tolerance band, is appropriate for the next five years,” RBI said in its report titled Reviewing the Monetary Policy Framework.

Finance minister Nirmala Sitharaman recently said the government will review the target band as the term of the MPC ends on March 31. The government will notify the average and the band within which the FIT will operate thereafter.

“It is important to recognise that while setting a single target/ tolerance band for the next five years, structural changes that may materialise or the type of shocks that may hit the economy are difficult to anticipate fully. Hence, flexibility must be built into the framework, without undermining the discipline of the inflation target, which has to be forward-looking to ensure that inflation expectations are firmly anchored over the medium term to facilitate decisions on investment, savings and consumption,” the report said.

The RBI report also suggested changes in the inflation targeting framework for better transparency, accountability and operational efficiency. This includes modifying the definition of failure from the current three consecutive quarters norm of inflation remaining outside the tolerance band, to four consecutive quarters.

The MPC may also consider providing a more explicit forward guidance on the interest rate path at a future date, as the projection process is strengthened further over time, the report suggested. Shut period for the MPC to start seven days before policy announcement and end three days after the day policy is announced is another change proposed.

Staggering on-boarding of external members on the MPC, having an official communication policy document, and releasing minutes within a week after the policy announcement were among other proposed changes.

Under India’s flexible inflation targeting approach, the central bank is expected to work to maintain retail inflation at 4%, with an upper tolerance limit of 6% and a lower limit of 2%.