From UPSC perspective, the following things are important :
Prelims level : MPC and inflation targets
Mains level : Paper 3- Inflation targeting by the RBI
Inflation targeting and legal provisions
- The inflation target, notified in August 2016, is 4%.
- The upper tolerance level was set at 6% and the lower tolerance level at 2%.
- Inflation was 6.7% in the January-March quarter, 6.6% in the April-June quarter and 6.9% in the July-September quarter.
- Breaching limits for any three consecutive quarters constitutes a failure to achieve the inflation target.
- In such an event, the Reserve Bank of India (RBI) is required to send a report to the Centre, stating the reasons for the failure to achieve the inflation target, the remedial actions it proposes to initiate, and an estimate of the time-period within which it expects to achieve the inflation target through the corrective steps proposed.
- Through amendments passed by Parliament in 2016, these new provisions were written into the RBI Act.
- They are aimed at ensuring enhanced transparency and accountability of the central bank.
Reason given by the RBI for missing the target
- The normal data collection exercise of the National Statistics Office was disrupted during the lockdown imposed due to the COVID-19 pandemic.
- The minutes of the Monetary Policy Committee (MPC) meeting after its August policy review suggest that the RBI’s defence for the breach of the 4% inflation target and 6% upper tolerance limit was the handicap of data limitations.
Issues with the reason given by the RBI
- The range around the inflation target that the Ministry provided to the RBI is for accommodating constraints and challenges like data limitations.
- The whole point of the range around the target, the statement emphasised, is that it “accommodates data limitations, projection errors, short-run supply gaps and fluctuations in the agriculture production”.
- RBI should be made to explain what it plans to do to control inflation.
- The central bank should be allowed to state expressly what support by way of government policy it needs to meet the inflation target.
- This can only strengthen the RBI’s hand; it should not let go of the opportunity to reinforce the MPC framework.
Transparency can enable more informed decision-making within the government, greater public scrutiny of the RBI’s performance, and an improved inflation-targeting regime. To slack off on it would be to compromise with the credibility, transparency and predictability of monetary policy.