Five-year inflation target under review

Stated 4% target could change after discussions between Centre & RBI

The originally proposed retail inflation target of four per cent, with a range of two per cent above or below, appears to be under a review. This has given rise to prospects of a new retail inflation target the Union government may agree to set for the Reserve Bank of India (RBI) for the next five years.

The Urjit Patel committee had set a retail inflation target of four per cent with a range of two per cent above or below. This was included in the Monetary Policy Framework Agreement, signed on February 20 last year. Since then, the central bank has been following this target as part of its monetary policy review exercise.

Senior officials from the Union finance ministry and the RBI will start discussions on a new inflation target for the next five years, as mandated in the amendments to the RBI Act through the Finance Bill, 2016, Business Standard has learnt.

In two notifications issued last Monday, the government stated the factors which constitute failure to meet inflation targets and brought into force the first part of Chapter XII of the Finance Act, 2016, which defines the Monetary Policy Committee (MPC).

However, the targets themselves were to be notified under the new Section 45ZA of the RBI Act. That section has not been added yet. The Centre has notified that if average inflation was more than the upper tolerance level of the target or less than the lower tolerance level of the target notified for any three consecutive quarters, it will be considered an MPC failure.

The monetary policy framework agreement, between the RBI and the ministry in February 2015, states Consumer Price Index-based inflation (CPI) at six per cent or above will be the upper tolerance limit and two per cent or below the lower one.

The target to be finally notified under Section 45ZA of the RBI Act will supersede the framework agreement. It had said the target for 2016-17 onwards would be four per cent (more or less, two per cent).

“The target set in the framework agreement was only till 2016-17 and that was one and a half years ago. Setting an inflation target for five years requires one to take a longer-term view. Hence, the RBI and the Centre will have further consultations on what that target will be, so that the monetary policy committee can work based on that,” said a senior government official aware of the developments.

EYE ON THE FUTURE
The finance ministry and the RBI will discuss inflation target for the next five years

In the bag

• Government notified the monetary policy committee and parameters for meeting target last week

Still waiting

• Targets yet to be notified
• Selection of the MPC nominees

Official stance

• More discussion required
• Long-term view required to notify new  target

Global developments have continued to remain volatile with the Brexit vote dampening prospects of a recovery in developed markets. This is likely to make the task of setting an inflation target challenging.

“The new target will be for five years starting 2016-17 onwards,” said a second official, who added consultations on the matter will be a “short process” and a target will be notified before the Monetary Policy Committee (MPC) starts its work. Sources declined to give a timeline on the matter.

The MPC could, in theory, start deciding interest rates from the August 9 monetary policy meeting, though there is no official confirmation on the matter. It will depend on how soon the government will have its three nominees on the panel in place.When asked if the target would remain at that range after discussions or would likely change, the first official quoted above said: “That may be your assessment. We will decide only after further consultations.”

The MPC has been tasked with deciding benchmark interest rates, hitherto a decision of the Reserve Bank of India (RBI) governor. After long disagreements on its composition between the ministry and RBI, it was agreed that it would have six members. The governor will head it. Three members — the governor, a deputy governor and an executive director — will be from RBI. The other three will be nominated by the government after recommendations of a search-cum-selection committee, headed by the Cabinet secretary. It will also comprise the economic affairs secretary and the RBI governor.

Each MPC member will have one vote, with the governor having an additional vote in case of a tie. Three members of the MPC will be experts in the field of economics or banking or finance or monetary policy, be appointed for a period of four years and not be eligible for re-appointment. The meetings shall be held at least four times a year and it shall publicise its decisions after each such meeting.