Amid growing speculation that the government may ask the central bank to loosen the inflation target to help push economic growth, a Reserve Bank of India (RBI) working paper has recommended that maintaining the inflation target at 4 per cent is appropriate for the country.
The paper, authored by Harendra Kumar Behera and Michael Debabrata Patra, finds that there is a steady decline in trend inflation to 4.1-4.3 per cent since 2014. Setting an inflation target below the trend may impart a deflationary bias to monetary policy because it will go into overkill relative to what the economy can intrinsically bear in order to achieve the target, says the paper titled 'Measuring trend inflation in India'.
"Analogously, a target that is fixed above trend renders monetary policy too expansionary and prone to inflationary shocks and unanchored expectations. Hence, maintaining the inflation target at 4 per cent is appropriate for India," it said.
The authors, however, believe that for setting monetary policy, it is necessary to consider significant changes in the overall macroeconomic ecosystem in which policy is conducted.
The RBI working paper, which seeks to examine whether the choice of the target for inflation is consistent with its trend, finds that the concept of trend inflation is vital for the design and conduct of monetary policy to which actual inflation outcomes are expected to converge after short run fluctuations from a variety of sources die out.
India formally adopted flexible inflation targeting (FIT) in June 2016 to place price stability, defined in terms of a target CPI (consumer price index) inflation, as the primary objective of the monetary policy. As per the current mandate, the RBI has to maintain headline inflation at 4 per cent by March 31, 2021, with an upper tolerance of 6 per cent and a lower tolerance of 2 per cent.
In the recently concluded Monetary Policy Committee (MPC) meeting on December 4, the RBI Governor Shaktikanta Das projected CPI inflation at 6.8 per cent for December quarter and 5.8 per cent for March quarter of the current fiscal (FY21). For H1 FY22, he said inflation is predicted to hover in the range of 4.6 per cent to 5.2 per cent with risks continuing to be broadly balanced.
Amid concern over elevated inflation, the MPC kept the benchmark interest rates unchanged at 4 per cent maintaining an accommodative stance.