Why in news?
The government can continue with the current Monetary Policy regime after it successfully completed its five year term.
What is the history behind the Inflation targeting?
- In May 2016, the Reserve Bank of India (RBI) Act, 1934 was amended to provide a Constitutional basis for the implementation of the flexible inflation targeting (FIT) framework.
- The act allows the Centre to set the inflation target in consultation with the RBI once every five years.
- On that basis, India’s inflation target was set at 4 % with a 2 % extension in the upper bound and 2 % in the lower bound.
Was this policy implementation successful?
- The average inflation rate measured through the GDP deflator which was 5.69 % five years in the pre-inflation targeting period has declined to 3.47 % in the last five years.
- India is one of the highest achievers of reducing inflation when compared to other Asian Nations..
- Consumer Price Index (CPI) inflation declined from 8.26 % during the 2011-2015 to 4.99 % in 2016-2019, a 3.27 % point fall.
- This is highest among both inflation-targeting countries as well as those that did not adopt it.
- India has also achieved a substantial fall in average inflation volatility during the said period.
- It was 7.93 % for five years before inflation targeting now declined to 0.89 % during the inflation targeting regime.
- This fall is highest compared to Indonesia, Thailand, Philippines and Korea.
How is this possible?
- This is possible because of the Central government’s strong coordination with monetary policy committee despite fiscal dominance in developing countries like India.
- This maintenance of a stable inflation rate provides certainty to inflation and investment decisions for sustainable growth.
- However, some critics of inflation targeting feel that its sole focus on price stability ignores growth imperatives.
- But the RBI Act rightly opted for maintaining price stability as its prime objective while giving due importance to economic growth.
- The real GDP growth did not decline during this period which was 6.50 % during 2011-2015 increased marginally to 6.63 % during 2016-2019.
How has transparency got improved?
- The Inflation Expectations Survey of Households (IESH) shows that the inflation expectation has been forward-looking in the post inflation targeting period in India.
- The lagged impact of past inflation expectations on current inflation expectations was significantly higher before the adoption of inflation targeting.
- This lagged dependency has fallen in the FIT framework regime which suggests that households are increasingly using the current and future information to form inflation expectations.
- This implies that transparency in monetary policy is helping to reduce inflation expectations.
How is this transparency is possible?
- RBI is following the international practices to increase communication with financial markets and the citizens.
- The frequency of the Monetary Policy Committee meeting is set at 6 times per year which is in line with most of the developed countries.
- RBI takes two weeks to release minutes of the proceedings of MPC, which provides a forecast of CPI inflation and GDP growth.
- Further, every 6 months, the RBI publishes a Monetary Policy Report where it explains the sources of inflation and provides an inflation forecast for 6-18 months ahead.
What can we infer from this?
- The inflation targeting in India has been a success story and India must continue with the FIT regime.
- The RBI has toiled to achieve its credibility and has rightly earned the goodwill and confidence of the financial markets around the world.
- The review committee should try to find out areas of further improvement in the monetary policy framework which will strengthen the MPC to achieve the inflation target.
- It should also disclose the models used in inflation and GDP forecasting as other inflation-targeting countries do.
- Further, the RBI may include a forecast of core inflation in the minutes.
Source: Business Line
