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A higher operative inflation target may hurt growth


The CPI numbers for February to be released on Friday, the last one before the current mandate, of 4 per cent with a band of 2 per cent movement either side, ends. Even as prices have started rising, the government is unlikely to revise the target as a higher band would hurt growth.

The recent firming up of food prices, cooking gas and rising petrol prices are expected to push CPI-consumer price index (CPI) inflation up to 4.85% in February from 4.1% in January, according to a report by BoA Securities. Unfavorable base effects are also at play. Despite this, inflation is still expected to stay within RBI‘s 2-6% mandate in the first half of calendar year 2021, it said. The report by Astha Gudwani and Indranil Sengupta say that operative target beyond 6 per cent would hurt growth.

This projection is significant since the current mandate for inflation target set by the government for the Reserve Bank’s monetary policy objective under its flexible inflation targeting regime comes up for review on March 31, 2021.

The Reserve Bank , in its latest Report on Currency and Finance, which is the voice of central bank’s in-house research has indicated that the current numerical framework for defining price stability-an inflation target of 4 per cent with a +/-2 per cent tolerance band- is appropriate for the next five years.

An RBI’s in house research findings published in the Report and Currency and Finance indicates that the central bank has factored in the impact of volatile food prices on inflation and hence the band. On the upper tolerance limit, international experience suggests that countries with a large share of food in the CPI basket tend to have higher inflation targets and wider tolerance bands. India’s share of food in the CPI basket is one of the highest among the emerging market peers with a share of 45.9 per cent, which makes CPI inflation prone to supply side shocks. Making the inflation target flexible by setting a band on either sides is useful in handling price volatility in anchoring inflation expectations.

“Threshold estimates over a longer sample period work out to 6 per cent, beyond which tolerance of inflation can be harmful to growth. Hence, the current tolerance band of +/-2 per cent may be retained notwithstanding the central tendency emerging from the country experience of lowering targets and narrowing bands over time” the RBI’s report said.

The current mandate for the RBI as a flexible inflation targeting central bank is achieve the medium-term target for CPI inflation of 4% within a band of +/- 2 per cent, while supporting growth. India adopted the Flexible Inflation Targeting (FIT) framework formally in June 2016.

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