Context: In each of the last three quarters, average inflation has not only exceeded the target, but has persisted above the upper tolerance limit set by the Centre.

More on the news: Inflation, as measured by the consumer price index (CPI), was 6.7% in the January-March quarter, 6.6% in the April-June quarter (based on imputed data) and 6.9% in the July-September quarter. 


The new monetary framework:

  • An agreement between the RBI and central government in 2015: It explicitly made inflation targeting the objective of the MPC while using the repo rate as the instrument for it.  
  • Target given to MPC: The Reserve Bank of India’s (RBI) MPC was given the target of keeping inflation at 4% +/- 2%. This meant that inflation should be between 2% and 6%. 
  • Contrasting target: It contrasted with the multiple indicator approach that predated this framework where the central bank focused on both growth and price stability.

Procedure of inflation targeting: 

  • Review meeting (every two months): Where MPC discuss the likely inflation and growth estimates over the coming months.
  • Targeting inflation using the policy rate: Based on this review, the MPC targets inflation using the policy rate, or the repo rate. 
    • When inflation is higher: Than the inflation target set by the central bank - then the MPC must increase the repo rate. 
    • When the actual inflation is lower than the target: The MPC could decrease the repo rate. 
  • Anchor: The MPC looks at consumer price inflation (CPI) as the inflation target that it must keep between 2% and 6%.
  • Average inflation overshooting the upper tolerance level or remaining below the lower tolerance level 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. 
  • Objectives: They are aimed at ensuring enhanced transparency and accountability of the central bank and are a key feature of the inflation-targeting regime agreed upon between the RBI and Finance Ministry.

Data limitations-RBI’s reasons for breach

  • Reports suggest that RBI has provided defence for the breach of the 4% inflation target and 6% upper tolerance limit was the handicap of data limitations. 
  • Coivid-19 disruption
    • The normal data collection exercise of the National Statistics Office was disrupted during the lockdown imposed due to the COVID-19 pandemic. 
    • The publication of the CPI had to be suspended for the months of April and May. 

Accommodative range: However, the range, according to the Ministry’s statement, allows for unanticipated short-term shocks to be accommodated.

  • The statement emphasised, is that it “accommodates data limitations, projection errors, short-run supply gaps and fluctuations in the agriculture production”. 
    • The last factor is an important one for CPI inflation, as food articles constitute about 46% of the CPI basket.
  • Also, the break that the RBI referred to is not visible in the inflation data. The data for the last four quarters — 5.8%, 6.7%, 6.6%, 6.9% — appears continuous. 

Way forward:

  • Clarity of policy objectives: The central bank should be allowed to state expressly what support by way of government policy it needs to meet the inflation target. 
  • 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.

Image source: The Hindu