 "Government notifies inflation target of 4% till 2021")
“Despite the shortcomings of CPI inflation, we welcome the decision to retain the inflation target, as this would impart continuity to policy setting, amidst the impending shift towards a Monetary Policy Committee-determined policy rate” said Aditi Nayar, Senior Economist, ICRA.
It is widely expected that with inflation currently at 5.77%, outgoing RBI Governor Raghuram Rajan will refrain from cutting rates at the next monetary policy review scheduled to be held on August 9. Thereafter the decision on the repo rate will rest with the Monetary Policy Committee chaired by the RBI governor.
Also Read
The government is yet to announce the names of the six member monetary policy committee (MPC). The MPC will comprise of three members from RBI – the governor, deputy governor and an officer of RBI, while the remaining will be appointed by the government The RBI governor will get a casting vote in case of a tie.
The notification comes at a time of renewed debate over the use of CPI as the inflation gauge. Many analysts have argued that as monetary policy exercises little control over food and beverage prices, which account for 45% of CPI, the Wholesale Prices Index (WPI) or core CPI – essentially CPI excluding food and fuel – is a better indicator.
“Core CPI is less volatile than headline CPI inflation, but may be too narrow a gauge for inflation targeting. Increasing the upper limit of the CPI inflation target above 6% may also not be appropriate,” Nayar said.
But with a better monsoon this year, analysts believe it could ease pressure on food supplies, bringing down food inflation, which has essentially driven overall inflation. This could create space for RBI to cut interest rates during the second half of the year.
"Under the unaltered inflation targeting framework, ICRA expects lower CPI inflation in H2 FY2017 to create space for additional monetary easing of 25 bps in 2016, regardless of the imminent appointment of the MPC and a new RBI Governor."