On 31 March 2021, the government put to rest doubts over India’s continuity with its macroeconomic goal of price stability. The government retained the target for inflation for the Monetary Policy Committee (MPC) of the Reserve Bank of India at 4% for the period 2021-2026, with a tolerance band of +/- 2 percentage points.
Inflation goal as ‘first among equals’:
Even as some economists and commentators have questioned India’s paranoia with inflation, the moot question is, should inflation targeting be accorded prime status in the hierarchy in India with other macro goals of growth and financial stability?
A perusal of history suggests that India’s inflation targeting compares very favourably with that of New Zealand, the pioneer in its adoption in 1989. New Zealand specifically defined price stability as an inflation rate in the 0-2% range, to be achieved by 1992 as a macro goal. It was only in 2019 that New Zealand extended the monetary policy goals to achieving the twin objectives of price stability and support of maximum sustainable employment, with the onus of this dual mandate lying with an MPC instead of a governor.
India, on the other hand, has remained obsessed with growth historically, especially just before and in the immediate aftermath of the global financial crisis. This could be partly attributed to inflationary pressures posing lesser concerns in these periods respectively, as also India’s emerging status. Such obsession meant that when India’s growth story took a hit in 2008 in the aftermath of the crisis, both the government and the RBI scrambled to make amends. A steep stimulus led to the Central government’s fiscal deficit increasing from 2.6% of GDP in 2007-08 to 6.1% of GDP in 2008-09, while a matching monetary policy stimulus reduced the policy rate by 475 basis points (4.75%) along with an assured liquidity of 10% of GDP. The long-distance runner had been given a steroid shot to boost short-term performance. And performance did improve and how! India’s growth rate shot up and peaked in 2010-11 at 8.5%.
Even as growth numbers resulted in waves of pleasure, the growing inflation numbers ought to have sent shivers down the RBI’s spine. For inflation quickly started spiralling and food inflation was at 20% in December 2009. While the RBI looked to the Wholesale Price Index—the headline measure for deciding monetary policy measures—the divergence between that and the Consumer Price Index was huge. While the 2009-10 WPI stood at a very manageable 3.8%, the CPI-Industrial Workers was at 12.4%. The situation became precarious after the US tapering tantrum of 2013 even as CPI inflation rose to 11.5% in November 2013. It was time to focus on inflation rather than being unclear about the relative position of growth, financial stability and inflation in a hierarchy. In 2014, the RBI decided to take a ‘glide path’ to reducing inflation, called the ‘disinflationary glide path’ to bring down inflation first to 8% by 2015 and then to 6% by 2016, when it adopted the flexible inflation targeting (FIT).
India was a late entrant onto the stage of inflation targeting in 2016—literally a new kid on the block, with 35 countries having adopted such a monetary regime prior to it. However, compared to New Zealand, which took three decades to set for itself a dual mandate of price stability and maximum sustainable employment, India’s FIT meant fixing an inflation target, while giving due emphasis to the objective of growth right from the time of adoption.
A suitable rate and associated bands:
Questions have been raised about the suitability of the 4% target rate, as also its associated lower and upper limit. Critics opine that a higher target or a pushing up of the upper limit, say to 3%, may give the RBI more headspace to address growth concerns through monetary policy measures. This is even more critical since such target rate is always assessed in relation to an estimated trend inflation. With people forming inflationary expectations that shape trend inflation, tracking of such a metric is important. In India, a trend inflation estimate of 4.1-4.3% forms the basis of a 4% target, since such a number would not require large policy measures to achieve the goal and thus add to monetary policy credibility.
However, it is crucial that this number be reaffirmed through other independent estimates, as also in a dynamic sense.Also critical is to estimate the level of threshold inflation, which provides the upper limit of the band. Studies contesting the 3-5% band adopted by most low- and middle-income countries as too conservative suggest that this is an important issue and the maintenance of a low enough upper threshold may be at the cost of sacrificing growth.
Why pursue inflation:
The pursuit of an inflationary target is most importantly to shape inflationary expectations. To put it simply, if all of us expect prices of onions to go up, they will indeed go up. A publicly announced inflation target, and a set of monetary policy measures implemented when actual inflation moves from these targets, results in credibility of central bank actions and helps shape various economic decisions. In the ultimate analysis, it is a win-win-win for growth, financial stability and inflation. Growth need not, in fact, be a ‘secondary’ goal.A sense of continuity is critical, especially when India has experimented with the inflation targeting framework for just five years against a tumultuous experience with inflation. However, it is important that the range and target be reassessed independently without an inherent bias towards either growth or inflation.
Tulsi Jayakumar
Professor, Economics and Chairperson, Family Managed Business at Bhavans SPJIMR
(Views are personal)
(tulsi.jayakumar@spjimr.org)