Maintaining 4 per cent inflation is appropriate for India as targeting a lower rate could impart deflationary bias to the monetary policy, said a Reserve Bank paper. Under the current dispensation, the RBI has been mandated by the government to maintain retail inflation at 4 per cent with a margin of 2 per cent on either side.
The paper, authored by RBI Deputy Governor Michael Debabrata Patra and another official Harendra Kumar Behera, has found a steady decline in trend inflation to 4.1-4.3 per cent since 2014. "A target set too below the trend imparts a deflationary bias to monetary policy because it will go into overkill relative to what the economy can intrinsically bear in order to achieve the target.
"Analogously, a target that is fixed above-trend renders monetary policy too expansionary and prone to inflationary shocks and unanchored expectations. Hence, maintaining the inflation target at 4 per cent is appropriate for India," RBI said in a release based on the paper. The paper notes that estimating trend inflation with regular updates is important for the formulation of monetary policy, irrespective of the country setting.
In India, this exercise acquires priority in the context of the flexible inflation targeting formally instituted in June 2016, which commits the central bank the RBI to a consumer price inflation target of 4 per cent with a symmetrical tolerance band of +/- 2 per cent around it, the authors said. The authors are from the RBI and the views expressed in the paper are those of the authors and not necessarily those of the institution to which they belong, the central bank said.
Moreover, section 45ZA of the Reserve Bank of India Act, 1934 mandates that the Central Government shall, in consultation with the Bank, determine the inflation target once in every five years. The inflation target has to be reviewed by end-March 2021. In this context, trend inflation provides the metric to gauge the appropriate level of the target going forward.
In a bid to keep inflation under specified level, the government in 2016 had decided to set up Monetary Policy Committee headed by the RBI Governor entrusted with the task of fixing the benchmark policy rate (repo rate). The six-member panel, which had its first meeting in October 2016, was given the mandate to maintain annual inflation at 4 per cent until March 31, 2021, with an upper tolerance of 6 per cent and lower tolerance of 2 per cent.