Home / Industry / Banking /  RBI favors retaining current inflation targeting regime

The Reserve Bank in a report on currency and finance (RCF) for the year 2020-21 said "the current numerical framework for defining price stability, i.e., an inflation target of 4 per cent with a +/-2 per cent tolerance band, is appropriate for the next five years."

The theme of the Report is “Reviewing the Monetary Policy Framework" which assumes topical relevance in the context of the review of the inflation target by March 2021 against the backdrop of structural changes in the macroeconomic and financial landscape that have prompted several central banks to undertake policy framework reviews.

The report said that the "period of study in this report is from October 2016 to March 2020 commencing with the formal operationalisation of the flexible inflation targeting (FIT) framework in India but excluding the period of the COVID-19 pandemic in view of data distortions."

Finance Minister Nirmala Sitharaman had earlier stated that the government would review the inflation target band as the five-year term for the Monetary Policy Committee (MPC) is coming to an end. RBI has the mandate to keep retail inflation at 4 per cent with a bias of plus/minus 2 per cent on either side.

The six-member MPC, headed by the RBI Governor, decides on the monetary policy keeping in mind this inflation target band.

Retail inflation eased to a 16-month low of 4.06% in January mainly on account of softening of food and vegetable prices, government data showed on Friday.

It is for the second consecutive month that retail inflation based on the Consumer Price Index (CPI) has remained within the target range of RBI which is 4 per cent ( /-2 per cent).

The retail inflation stood at 4.59 per cent in December 2020 and 7.59 per cent in January 2020. The previous low for retail inflation was in September 2019 at 4 per cent.

Here is some highlights of what the report said

In the international experience, inflation targeting emerging market economies (EMEs) have generally lowered their inflation targets and narrowed tolerance bands.(EMEs) have generally lowered their inflation targets and narrowed tolerance bands.

During the period under review, headline CPI inflation averaged 3.9 per cent in India with a decline in inflation volatility, attesting to the success of flexible inflation targeting (FIT) in terms of its primary mandate.

The institutional architecture of FIT in India, including the size of the monetary policy committee (MPC) and its composition, the decision making process, communication practices and accountability mechanisms is in line with international best practices, while the definition of the time horizon of failure, processes of onboarding of MPC members, some aspects of forward guidance and timings relating to release of minutes, shut periods and release of transcripts warrant a review.

During the FIT period, monetary transmission has been full and reasonably swift across the money market but less than complete in the bond markets; while there has been an improvement in transmission to lending and deposit rates of banks, external benchmarks across all categories of loans and deposits could improve transmission further.

In the conduct of monetary policy in an open economy setting, foreign exchange reserves and associated liquidity management are key; hence, there is a need to enhance the RBI’s sterilisation capacity to deal with surges in capital flows.

The primary focus of FIT on price stability augurs well for further liberalisation of the capital account and eventual internationalisation of the Indian rupee.

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