Acharya's wish: RBI needs to deliver 4% retail inflation year after year

Reminds analysts, bond markets that inflation target is 4% and not 6%

As the retail price inflation surges past seven per cent in July and is expected to remain elevated for at least one more month, advice from former Reserve Bank of India (RBI) deputy governor Viral Acharya holds relevance.

He says the RBI needs to deliver inflation prints around the mandated target of four per cent for several years to ensure domestic and external financial stability.

"It would be good for India, its common man, and its domestic and external financial stability, if the Reserve Bank were to revert credibly and soon, to delivering realised inflation prints that average around the mandated target on a durable basis, that is, for several years," he writes in a new prelude to his authored book, titled Quest for Restoring Financial Stability in India.

Otherwise, the gains from adopting inflation targeting such as permanent lowering of inflation expectations and long-term borrowing costs will not fully materialise, he warns in the prelude to the book, published by Penguin Random House India. The new prelude was written on February 14, 2023.

It should be noted that Acharya talks about average inflation of four per cent for years and not monthly inflation. Average inflation in the first four months of the current financial year stood at 5.3 per cent. The monetary policy committee (MPC) of RBI expected the inflation rate to average 5.4 per cent in the current financial year. It projected inflation to be 5.2 per cent in even the first quarter of FY25. This meant that the goal of four per cent may remain elusive, at least till then.

Acharya also reminds analysts and bond markets that the retail inflation target for the central bank is four per cent and not six per cent. Hopes around six per cent make it difficult to contain inflationary expectations, he cautions.

"Public commentary, analyst sighs of relief or cries of concern, and bond market expectations, are now all centred around 6 per cent, the upper limit of the band around the consumer price inflation target for the Reserve Bank, rather than at the target of 4 per cent. This suggests that inflation expectations risk becoming unanchored," he says.

The RBI has been mandated by the government to keep the consumer price index-based inflation rate at four per cent plus or minus two.

Acharya says in the footnote that the +/- 2 per cent band around the target headline inflation rate of 4 per cent was meant to account for inevitable measurement noise in inflation rather than to allow the MPC and its Reserve Bank members to shift around the focal point of monetary marksmanship.

Keeping headline inflation is one of his wishes. One of the others is about undertaking more fiscal consolidation.

Acharya finds the general fiscal deficits, public sector borrowing requirements and the sovereign debt-gross domestic product (GDP) ratio as "uncomfortably high," which could make the economy vulnerable to even mild disturbances.

This could result in deviation of the central bank from its objectives, he warns.

"I say ‘uncomfortably high’ as relatively moderate shocks still have the potential to leave the economy precarious to short-term policymaking—including central banking compromises—that will start managing the fiscal arithmetic rather than enabling the private engines of stable long-term growth," Acharya writes in the prelude.

As cited above, the new prelude was written on February 14, 2023, which means that the Union Budget for 2023-24 was presented by then. The Budget projected the Union government's fiscal deficit to come down to 5.9 per cent of GDP during the current financial year from 6.4 per cent in 2022-23. Acharya, however, referred to the general fiscal deficit, which refers to the combined level of both the Union and the state governments.

To a query over which period he was referring to, Acharya provides various graphs which point to these high levels, including estimates for FY24.

In the introductory chapter, 'Fiscal Dominance—A Theory of Everything in India' in the book, he explains as to why during his term as the RBI deputy governor the general fiscal deficit was a persistent concern and kept raising its ugly head in dominating virtually everything about India’s central banking.

Acharya was RBI deputy governor from January 23, 2017, to July 23, 2019.

"With a part of fiscal consolidation at the centre occurring at the expense of states, inflation remaining stubbornly high, job creation lagging the pace at which youths are entering the labour force and a national election coming up soon, the level of the general fiscal deficit remains a relevant concern," he says.

He proposed setting up an independent fiscal council to restore fiscal prudence.

Successive finance commissions have also recommended constituting such a council comprising experts to evaluate expenditure and revenue policies of the government, but the finance ministry has junked the idea.

Acharya explains that deviations from fiscal targets were meant to be one-off temporary deviations but those are turning out to be repetitions and an entrenched characteristic of the economy since macroeconomic shocks occur without notice.

He says enjoying this fiscal flexibility year after year would not help the cause of attaining the long-run growth potential of an increasingly private-sector Indian economy.

Acharya, however, commended the government for making some progress in doing away with accounting tricks to manage the fiscal deficit and focusing instead on rationalisation from revenue to capital expenditures. The Modi government has cleaned the budgets from off-market borrowings from 2020-21 onwards.