The Indian government has kept the inflation target for the next five years at “the same level” as it is currently, according to Secretary of Economic Affairs Tarun Baja. A detailed notification is awaited.
India’s current inflation target is set at 4 (+/- 2)%. The target, the first of its kind in the history of Indian monetary policy, was set in August 2016 and was valid until 31 March 2021. A six-member monetary policy committee, which includes three officials from the Reserve Bank of India, was entrusted with meeting the inflation target.
The existing flexible inflation framework has served the Indian economy well and helped anchor inflation and inflation expectations; thus preserving overall macroeconomic stability in the economy, said Shubhada Rao, founder of QuantEco Research. “We believe it is imperative to continue with the framework without repetition,” she said.
Abheek Barua, chief economist at HDFC Bank, said the inflation target, which is set at the same level, is good in the long run and that changing the nominal anchor would escalate inflation expectations. Given the range of 4 (+/-) 2%, there is enough room for continued discretion, he added.
How will the bond market react?
Repetition of the inflation target will mean that the MOC will have to keep an eye on inflation.
After a brief drop to 4% in January, retail sales rose again above 5% in February. Retail inflation remained above the RBI target of 4 (+/- 2)% for eight months in the current financial year. If inflationary pressures continue, the MPC may need to accelerate its normalization process after the Covid-19 shock.
So far, the RBI committee and governor Shaktikanta Das have assured that the policy will remain flexible in the next financial year. Explaining the MPC guidelines in Das, Das said the commitment to maintaining an flexible attitude “during the current financial year and into the next financial year” reflects the time guidelines; whereas, on the other hand, the term ‘revitalize growth on a lasting basis’ characterizes national guidelines; that is, guidelines that depend on the state of the economy.
Despite the fact that bond markets can worry about faster normalization of monetary policy, Barua said.
Rao, however, said that in the medium term, the continuation of the existing inflation target should be comforting for bond markets. “Bond markets should respond positively by continuing the same framework as this has helped anchor inflationary expectations that should curb negative sentiment. “Higher inflation would mean higher interest rates,” she said.
Synchronized with RBI display
The government’s opinion is in line with the central bank’s position.
Prior to the audit, the RBI’s research department advocated maintaining the inflation target. “The current numerical framework for price stability – an inflation target of 4% with a +/- 2% tolerance range – is appropriate for the next five years,” the RBI said in its “Currency and Finance Report” published in March.
“The inflation trend according to which real inflation converges after a shock is an appropriate measure of the inflation target,” the report said. “The inflation trend dropped from more than 9% before the FIT to a range of 3.8-4.3% during the FIT, indicating that 4% is the appropriate level of inflation target for India.”