On the last day of the financial year 2020-21, the Finance Ministry announced that the inflation target for the five years between April 2021 and March 2026 will remain unchanged at 4% (+/-2 %).

Inflation targeting in India

• India had switched to an inflation target-based monetary policy framework in 2015, with the 4% target kicking in from 2016-17.
• Many developed countries had adopted an inflation-rate focus as an anchor for policy formulation for interest rates rather than past fixations with metrics like the currency exchange rate or controlling money supply growth.
• Emerging economies have also been gradually adopting this approach.

Try this PYQ:

Which one of the following is not the most likely measure the Government/RBI takes to stop the slide of Indian rupee?

(a) Curbing imports of non-essential goods and promoting exports

(b) Encouraging Indian borrowers to issue rupee denominated Masala Bonds

(c) Easing conditions relating to external commercial borrowing

(d) Following an expansionary monetary policy

What is the rate of consumer price inflation?

• Moody’s Analytics recently pointed out that volatile food prices and rising oil prices had already driven India’s consumer price index (CPI)-based inflation past the 6% tolerance threshold several times in 2020.
• While inflation headwinds remain, especially with oil prices staying high, there was some speculation that the Central government may ease up on the inflation target by a percentage point or two.
• This would have given the Reserve Bank of India (RBI) more room to cut interest rates even if inflation was a tad higher.

What is the RBI’s position on this?

• The RBI had, in recent months, sought a continuance of the 4% target with the flexible tolerance limits of 2%.
• The 6% upper limit, it argued, is consistent with global experience in countries that have a large share of food items in their consumer price inflation indices.
• Accepting inflation levels beyond 6% would hurt the country’s growth prospects, the central bank had asserted.

Why should these concern consumers?

• The central bank’s monetary policy and the government’s fiscal stance may not have necessarily reacted to arrest inflation pressures even if retail price rise trends would shoot past 6%.
• As high oil prices spur retail inflation higher, the central bank is unhappy as its own credibility comes under a cloud if the target is breached.
• If the upper threshold for the inflation target were raised to 7%, the central bank may not have felt the need to seek tax cuts (yet).
• Thus, the inflation target makes the central bank a perennial champion for consumers vis-à-vis fiscal policies that, directly or indirectly, drive retail prices up.

Back2Basics:

Types of Inflation: Demand Pull, Cost Push, Stagflation, Structural Inflation, Deflation and Disinflation

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