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Home >Opinion >Views >India must not weaken its resolve on inflation

The Reserve Bank of India’s (RBI’s) retail inflation target is scheduled for review once its validity expires early next year. Under the flexible inflation-targeting regime adopted by the country in 2016, it is currently set at 4%, with leeway of 2 percentage points above and below it. After covid pushed our economy into a deep recession, calls for this target band to be relaxed have grown louder. Doing so would grant our central bank more space to keep its policy rates of interest low for longer in support of growth, argue advocates of a relaxation. Some would even have us abandon the framework entirely, arguing that rising prices in India need not always reflect excessive money supply, and instead let RBI formulate its monetary policy for a judicious mix of economic aims, as was the case earlier. Any such move, however, would be ill-advised. Along with India’s adoption of a bankruptcy code and the goods and service tax, RBI’s mandate to maintain price stability was a major reform of the Narendra Modi government’s first term in office. For the sake of our economy’s future, it deserves neither dilution nor dumping. The prime purpose of the 2016 shift, the creation of a stable monetary basis for sustainable long-term growth, must not be lost sight of.

It is true that India’s economic contraction, as seen in early estimates for the first half of 2020-21, necessitated cheap credit as RBI’s top priority in its laudable effort to keep commerce going and contain the pain. However, this shock was caused by a one-off event, our nationwide lockdown, the easing of which has allowed commercial activity to resume by and by. Latest indicators suggest that a rebound could well be underway from the depths touched earlier this year, setting the stage for strong growth in 2021-22 on a shrunken base. Unless supply somehow keeps pace, a sudden increase in demand could push prices up. Ample liquidity underlines this risk. Apart from using other tools of cash infusion, our central bank has dropped its key policy rate—the one at which it lends money to banks—by more than a whole percentage point in 2020 so far. At 4% now, its repo rate is well below inflation, which has now stayed above RBI’s upper limit of 6% for a span of time too long to be dismissed by economic agents as a blip.

It is also true that any over-indebted government could be tempted to inflate some of its debt away by letting prices rise. This should be resisted. Our past experience shows that inflation is a little like wildfire—hard to contain once it breaks loose. Not only does it singe the common man, especially the poor for whom high inflation acts like a regressive tax, it is repressive of savers who find the real value of their savings depleted if interest rates fail to compensate for it. In general, negative or poor returns on capital in an economy would engender the risk of pushing it into a “liquidity trap", as private agents would have no incentive left to lend money. It is the promise of price stability that allows us to rely on long-range financial projections made in Indian rupees. Importantly, that avowal also lowers risk premiums in the extended credit market and thus eventually the overall cost of capital, which is crucial to growth. From a classic perspective, the stability of a currency is the core job of its issuer. Let’s not undo our hard-fought pre-2020 gains on inflationary expectations by letting monetary myopia get the better of our long-term interests. We mustn’t let covid weaken our resolve against inflation.

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