BackGovt mulls 5% inflation target to give RBI room to trim rates
In 2016, the govt notified 4% CPI inflation as the target for the period from 5 August 2016 till 31 March 2021
PremiumThe government is considering a proposal to raise the consumer price index (CPI)-based inflation target under the monetary policy framework by a notch to 5% with a tolerance level of plus and minus 2% from 1 April to give more leeway to the Reserve Bank of India (RBI) to cut policy rates to boost growth in the pandemic-ravaged economy.
The proposal will be announced along with other fiscal measures in the Budget for FY22 aimed at reviving growth, two persons aware of the development said.
According to the first advanced estimate by the National Statistical Office, India’s gross domestic product is expected to shrink 7.7% this fiscal year through March.
A final decision on the proposal to raise the retail inflation target is still awaited as some experts in the government and at the central bank prefer status quo. But some among them are of the view that it is time to take robust fiscal and monetary measures to revive growth, the people cited above said, requesting anonymity.
The government in 2016 notified 4% CPI inflation as the target for the period from 5 August 2016 till 31 March 2021 with an upper tolerance limit of 6% and the lower limit of 2%.
As per the RBI Act, 1934, the government, in consultation with the central bank, has to finalize the inflation target for the next five years starting 1 April and also get it passed by Parliament, one of the two people said. “We expect a consensus to emerge soon as the government intends to get it passed in the current Budget session," he added.
The finance ministry and RBI did not respond to emailed queries.
“The need to raise the limit is felt more when RBI had to pause interest rate cuts because retail inflation soared to a 77-month high in October (7.61%) and stayed above the specified range in November (at 6.9%) at a time when the economy was struggling and requ-ired more stimulus," the person cited above said.
The economy was hit hard by covid and the nationwide lockdown. The economy contracted by 23.9% in the June quarter, although it recovered to shrink by a narrower 7.5% in the September quarter.
Although retail inflation fell sharply to 4.6% in December, below the upper limit of RBI’s tolerance range of 6% for the first time since March 2020, it averaged 6.6% in the first nine months of this fiscal, ruling out an immediate cut in interest rate by RBI. The RBI’s monetary policy committee is expected to meet next month.
Audit and consulting firm EY India said in its latest edition of Economy Watch that the current inflation target with an upper limit of 6% does not allow RBI to cut policy rates. “Using actual data for the first three quarters and RBI’s expectation for the last quarter, the annual CPI inflation rate may turn out to be 6.4% for FY21. Since this is higher than the upper tolerance limit of the monetary policy framework, the expectation is that the monetary authorities may not be forthcoming with any further relaxation in repo rate in the near future," it said.
EY India’s chief policy adviser D.K. Srivastava said, “Given the past experience, it may be desirable to raise the mid-point of the CPI inflation target range from 4% to 5%. This may imply a nominal GDP growth rate that is higher than the real GDP growth rate by about 3-4% points on average. The range may still be kept at plus/minus 2% points. Thus, the target range for CPI inflation would be 3% to 7%. This would facilitate a higher tax revenue growth for the central and state governments, supporting growth and plans for fiscal consolidation."
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