Inflation targeting and legal provisions

• The inflation target, notified in August 2016, is 4%.
• The upper tolerance level was set at 6% and the lower tolerance level at 2%.
• Inflation was 6.7% in the January-March quarter, 6.6% in the April-June quarter and 6.9% in the July-September quarter.
• Breaching limits for any three consecutive quarters constitutes a failure to achieve the inflation target.
• In such an event, the Reserve Bank of India (RBI) is required to send a report to the Centre, stating the reasons for the failure to achieve the inflation target, the remedial actions it proposes to initiate, and an estimate of the time-period within which it expects to achieve the inflation target through the corrective steps proposed.
• Through amendments passed by Parliament in 2016, these new provisions were written into the RBI Act.
• They are aimed at ensuring enhanced transparency and accountability of the central bank.

Reason given by the RBI for missing the target

• The normal data collection exercise of the National Statistics Office was disrupted during the lockdown imposed due to the COVID-19 pandemic.
• The minutes of the Monetary Policy Committee (MPC) meeting after its August policy review suggest that the RBI’s defence for the breach of the 4% inflation target and 6% upper tolerance limit was the handicap of data limitations.

Issues with the reason given by the RBI

• The range around the inflation target that the Ministry provided to the RBI is for accommodating constraints and challenges like data limitations.
• The whole point of the range around the target, the statement emphasised, is that it “accommodates data limitations, projection errors, short-run supply gaps and fluctuations in the agriculture production”.

Way forward

• RBI should be made to explain what it plans to do to control inflation.
• The central bank should be allowed to state expressly what support by way of government policy it needs to meet the inflation target.
• This can only strengthen the RBI’s hand; it should not let go of the opportunity to reinforce the MPC framework.

Conclusion

Transparency can enable more informed decision-making within the government, greater public scrutiny of the RBI’s performance, and an improved inflation-targeting regime. To slack off on it would be to compromise with the credibility, transparency and predictability of monetary policy.

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now