RBI’s Inflation Target: Continuity or Change?

As the Reserve Bank of India (RBI) approaches the deadline for submitting feedback on its monetary policy framework, former members of the Monetary Policy Committee (MPC) are advocating for continuity in the inflation target set at 4%. This target was officially adopted in August 2016 and is crucial for stabilizing public expectations regarding inflation.

The RBI’s current framework includes a tolerance band of 2-6% around this target, which is reviewed every five years. The RBI has released a discussion paper inviting comments on key issues such as whether to focus on headline versus core inflation, and if the 4% target remains optimal. Economists like Ashima Goyal argue that retaining this target has been beneficial in managing inflationary expectations.

Since shifting its focus to retail inflation in 2014, the RBI has seen a notable decline in CPI inflation, dropping from nearly 10% in 2012-13 to a projected low of 3.1% in the current fiscal year. This decline is attributed to favorable conditions such as a good monsoon and GST rate cuts. Low inflation is viewed as essential for sustainable economic growth, as rising prices can reduce consumer purchasing power.

While some, like Janak Raj, former executive director at the RBI, believe any change to the inflation target could be risky, others, including former IIM-Ahmedabad professor Ravindra Dholakia, suggest a more practical approach. Dholakia argues for an inflation target of around 5.5%, claiming that the current 4% target could hinder necessary structural changes for India’s development.

Amid this debate, a former MPC member has proposed reducing the tolerance band, suggesting a target of 3.5% and a revised range of 2-5.5%. However, Raj cautions that given the historical volatility of CPI inflation, any adjustments could compromise the credibility of the RBI and its inflation targeting framework.

The recent Economic Survey has also reignited discussions on whether the RBI should prioritize headline inflation or exclude food items from its calculations, as food constitutes a significant portion of the CPI. Despite these suggestions, the RBI maintains that food prices cannot be overlooked in monetary policy formulation.

Ultimately, as the RBI evaluates its inflation targeting strategy, the balance between maintaining stability and adapting to economic realities will be crucial for India's economic future.