Ex MPC member thinks India's threshold inflation level is 6 per cent

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  Ex MPC member thinks India's threshold inflation level is 6 per cent

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• The story: The government decided to focus on inflation control as the key RBI strategy since 2016. The 'Flexible Inflation Targeting' model was adopted for 5 years, and renewed therafter for another five, till 2026. As part of it, the Monetary Policy Committee (MPC) of the RBI decides the repo rates and other policy matters, every two months. The inflation target is 4% plus minus 2%, base on CPI measure.
• Latest update: As per a research paper by former monetary policy committee (MPC) member Ravindra Dholakia, India's inflation levels may be needed to be managed at its higher end of the target band to achieve its potential growth. The threshold inflation level for India is 6 per cent.

1. This is significant as the RBI adopted FIT framework as a formal monetary policy objective since 2016, under which price stability is the prime goal of monetary policy and the government sets an inflation target for the central bank.
2. The threshold inflation for India at around 6 per cent. An inflation target that is lower than the threshold level, cannot achieve its potential output growth and the system would remain in long-run disequilibrium requiring constant policy interventions to stabilize.
3. The current target is set at 4 per cent which can range in a band of 2 per cent either ways, which was set in April 2021 when the new MPC term started. 
4. The inflation targeting framework came for criticism from various quarters as CPI inflation crossed 6 per cent, beyond the upper end of the band for several months in FY'21 due to the restrictions caused by the pandemic induced nation-wide lockdown.

• Threshold inflation: The study shows that the threshold inflation and corresponding growth depends on the other two parameters – the ratio of fiscal deficit to GDP and current account deficit to GDP. The concept of 'threshold inflation' is linked to the level of inflation beyond which it becomes detrimental to economic growth.  The study estimated the trade-off between long run inflation and steady state growth rate. A 100 bps (one bps is 0.01 per cent) reduction in inflation from the threshold level could result in 40 bps loss in growth and 15 bps of gain in the growth for 100 bps reduction in inflation towards the threshold level. 
• Impact of rate target: Policymakers can choose to set the inflation target below the threshold level only after considering the costs of sacrificing growth and implied poverty alleviation rate with likely benefits in terms of the distributional and financial stability implications which are not examined in this study.
• Summary: Clearly, the pressure to help on GDP growth is telling on the RBI policymakers. Though this is not the prime mandate of the central bank, the government is under pressure for long now, given the earlier slow growth quarters, and then the Covid-induced sharp contraction.

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