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Success of inflation targeting in India - an analysis
Read more on - Polity | Economy | Schemes | S&T | Environment
- The story: Both the RBI and the government have decided that the existing "Flexible Inflation Targeting" system will not be changed for next five years. For 2021-2026 also, the RBI will continue with the current Monetary Policy regime, just like it did for 2016-2021.
- How inflation targeting evolved: In May 2016, the Reserve Bank of India (RBI) Act, 1934 was amended to provide a Constitutional basis for the implementation of the flexible inflation targeting (FIT) framework. The Act allowed Centre to set the inflation target in consultation with the RBI once every five years. On that basis, India’s inflation target was set at 4 % with a 2 % extension in the upper bound and 2 % in the lower bound. Anchoring was with Consumer Price Inflation (CPI).
- Successful or not: The policy has been followed carefully since 2016, with the RBI's MPC issuing policy statements every two months. The goal was price stability, for ensuring political stability (not explicitly said, but understood). Jobs and employment generation were not a part of this policy.
- The average inflation rate measured through the GDP deflator which was 5.69 % five years in the pre-inflation targeting period has declined to 3.47 % in the last five years (2016-2021).
- India is one of the highest achievers of reducing inflation when compared to other Asian Nations.
- The Consumer Price Index (CPI) inflation declined from 8.26 % during the 2011-2015 to 4.99 % in 2016-2019, a 3.27 % point fall. This is highest among both inflation-targeting countries as well as those that did not adopt it. India has also achieved a substantial fall in average inflation volatility during the said period. It was 7.93 % for five years before inflation targeting now declined to 0.89 % during the inflation targeting regime.
- This fall is highest compared to Indonesia, Thailand, Philippines and Korea.
- What led to this: Experts claim this happened due to the Central government’s strong coordination with monetary policy committee despite fiscal dominance in developing countries like India. This maintenance of a stable inflation rate provides certainty to inflation and investment decisions for sustainable growth. But critics of inflation targeting feel that its sole focus on price stability ignores growth imperatives, and India is hence, stuck in a jobless growth environment. The real GDP growth did not decline during this period which was 6.50 % during 2011-2015 increased marginally to 6.63 % during 2016-2019. But the problems with the policy were visible from 2018, when the rate of GDP growth steadily fell, quarter after quarter.
- Transparency: The Inflation Expectations Survey of Households (IESH) shows that the inflation expectation has been forward-looking in the post inflation targeting period in India. The lagged impact of past inflation expectations on current inflation expectations was significantly higher before the adoption of inflation targeting. This lagged dependency has fallen in the FIT framework regime which suggests that households are increasingly using the current and future information to form inflation expectations. This implies that transparency in monetary policy is helping to reduce inflation expectations.
- How achieved: The RBI is following the international practices to increase communication with financial markets and the citizens. The frequency of the Monetary Policy Committee meeting is set at 6 times per year which is in line with most of the developed countries. RBI takes two weeks to release minutes of the proceedings of MPC, which provides a forecast of CPI inflation and GDP growth. Further, every 6 months, the RBI publishes a Monetary Policy Report where it explains the sources of inflation and provides an inflation forecast for 6-18 months ahead.
- Learnings: Apparently, it can be claimed that inflation targeting in India has not failed, and India must continue with the FIT regime. The RBI has managed to contain the inflationary pressures, though growth has suffered hugely in recent quarters (even before the pandemic struck in 2020). The review committee should try to find out areas of further improvement in the monetary policy framework which will strengthen the MPC to achieve the inflation target. It should also disclose the models used in inflation and GDP forecasting as other inflation-targeting countries do. Further, the RBI may include a forecast of core inflation in the minutes.
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