The Union government is reportedly considering a change in the inflation targeting mechanism and to ask the Reserve Bank of India to dilute its hard core inflation targeting stance for formulation of monetary policy. The current mechanism for inflation targeting was introduced several years back when the Parliament had mandated a broad inflation targeting band as the guiding principle for RBI’s monetary policy.
Now, in the context of the deep economic crisis created by the Covid-19 pandemic, the government is suggesting that a broader band of inflation should be put in place of the present band of 2% to 6%.
But the question is: how broad should be the inflation targeting band? Isn’t a 2-6% band already broad enough? The RBI governor, Shaktikanta Das, is already said to be opposed to any serious tampering with the inflation targeting now in place. He feels any dilution of the band, by further stretching it, would make the whole system meaningless. But, then why is the government seeking such a course of action. Surely, the North Block could not be unaware of the implications of any such move.
Published: undefined
However, the government is feeling that the central bank should go soft on inflation targeting and be more accommodate to ensure growth in the current context. A more accommodative stance of the central bank should help faster economic recovery process.
The Indian economy had shrunk by close to 25% in the first quarter of the current fiscal year. In the next, the economy shrank still, but by a far reduced margin. With a little luck, in the next quarter the figures could even show a positive — albeit small- growth in the GDP.
Inflation has all of a sudden come to centre stage in a discourse on economy. Prices are rising all over, after a very long period of subdued inflation. So the central bankers and finance ministries to the interested public, all are talking of inflation from the supply line disruptions caused by the pandemic.
Published: undefined
Not only in India, the world over governments and central banks are now discussing the comparative claims of maintaining an accommodative stance of monetary policy and need to rein in price lines.
After a long time, the prices are rising and economists are convinced that post-cold pandemic prices are all set to rise again. This is because of huge injection of stimulus funds into the global economy by all major economies. With such infusion of liquidity, there is bound to be pressure on prices.
Till about the 1970s, the global economy has seen steady rise in prices and monetary policy had anchored their policies on inflation control. From late 1980sl the global economy had witnessed falling prices.
In India, we have witnessed defiant rise in prices — particularly of food articles— even till 2010s. Thereafter prices had remained subdued. The endemic had disrupted established supply chains and productive and trading channels. As a result of the snapping of established business links, supplies have become erratic. Hence, some price shocks are inevitable.
Published: undefined
A reformulation of RBI’s policy is critical now because prices are creeping up and overall policy can get unstuck by generalised inflation. The RBI targets to keep inflation at 4%, plus or minus 2%. That works out a range for inflation between 2% and 6%.
Some of the latest inflation prints show inflation rate for the Indian economy more at 6% than at the lower end of the spectrum. This will mean that the RBI should follow a more hawkish policy ad raise interest rates now to bring inflation under control.
That will surely put a brake on the incipient recovery which has started. While in the worst quarter the Indian economy shrank by 25% under the brunt of the Covid-19 pandemic, the rate of contraction had come down to around 7% in the latest quarter.
With continuation of the accommodative stance, it is hoped that by the middle of next year there will be a turn-around and the economy will see positive growth again. Any restrictive monetary policy at this stage could vitally affect the resumption to normalisation process.
The government believes that the Indian economy now needs further stimulus measures for softening the blow from the pandemic than tightening of the policies to keep inflation under control.
RBI is the final economic authority which is tasked to maintain a stable price line.
A related issue is the RBI funding of government’s borrowing which is happening now. Ever since the imposition of the lock down and gradual normalisation of the economy’s functioning, government has been introducing ever bigger stimulus packages. The borrowings from RBI are useful for meeting the additional costs of the stimulus packages.
A restrictive policy will also crimp this funding available to the union government.
The deliberations on inflation targeting have begun but should be resolved quickly as any delay in decision could upset the co-ordination of policy formulation.
Published: undefined
IPA
Published: undefined
Follow us on: Facebook, Twitter, Google News, Instagram
Join our official telegram channel (@nationalherald) and stay updated with the latest headlines
Published: undefined