To keep inflation under a tight leash and to bring about a measure of certainty in the direction of monetary policy, the Reserve Bank of India has put in public domain the Monetary Policy Framework Agreement which is being seen as the most significant monetary policy reform undertaken in the past two decades of liberalisation. Starting next fiscal, the RBI would be deemed to have failed to meet the target if inflation were to rise above 6 per cent for three consecutive quarters. The target would also be considered missed if inflation falls under 2 per cent for three consecutive quarters in any year.
While the RBI has been made responsible for any failure to meet the inflation target, the Centre cannot absolve itself of its responsibility. Inflation in India is primarily driven more by supply-side bottlenecks which only the government can fix. Unless the Centre reduces its fiscal deficit, and improves the quality of the deficit by controlling expenditure, inflation targeting will not work. This agreement will then go the way of the fiscal responsibility and budget management law, where pious intentions are more often than not trumped by political compulsions. The changes bring closer to reality a goal pursued relentlessly by RBI governor Raghuram Rajan, who has said that inflation targeting, more commonly seen in developed economies, was also vital in India.
The RBI will aim to bring inflation below 6 per cent by January 2016. The target of financial year 2016-17 and all subsequent years shall be four per cent with a band of (+/-) 2 per cent, as per the agreement. While the agreement gives a free hand to the RBI governor to decide on the monetary policy measures to achieve the inflation target, it also requires the central bank to give out to the Union government a report in case the target is missed for a period of time. While the onus has been fixed on the RBI, in reality there is a tacit understanding that the Centre too would bear its own share of responsibility. There is no denying that this is a worthy reform.