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What could be the new normal for inflation?

Lot has changed since normal level was set at 4-5%

Dilasha Seth  |  New Delhi 

Former RBI Governor Y V Reddy has found takers among economists for his idea mooted recently that the central bank should revisit its normal rate for from the current 4-5% since it was set before India was integrated with the global economy.

However, Prime Minister's Economic Advisory Council Chairman C Rangarajan, himself a former RBI governor, favours retaining the current comfort zone in terms of

At a panel discussion recently, Reddy had argued that a lot has changed after the was set at 4-5% on multiple fronts like the integration of the domestic economy with the global economy and the rising government borrowings, which has resulted in being consistently at high levels .

This, he had said makes a case for revising target to a more reasonable level.

Any change in number assumes importance since it may have an effect on RBI's monetary stance.

However, when prodded by Reddy at the discussion, RBI Governor Subbarao had said that it may not change the number, but will certainly revisit the strategy.

Rangarajan told Business Standard that the normal need not be revised.

Headline averaged 8.5% in 2011-12 but has subsided to about 7-8% till October this fiscal. In October, the wholesale-price stood at 7.45%, down from 7.81% in September.

In 1998, Rangarajan himself had called rate at 6–7% as “acceptable level” of His idea of threshold was: at what level of do adverse consequences set in?

However he now said,“then level was as high as 10-11%, so cutting down to 6% was also very difficult”.

He noted that high creates problems on the exchange rate side and it is desirable to contain to 4-5%, a comfort zone as set by RBI. The central bank should work towards the target. 

Rupee has depreciated a lot against the US dollar in the last one-and-a-half years. The exchange rate was hovering at Rs 48 per dollar in June-July last year, it depreciated to touch a low of Rs 56 this fiscal and stands at Rs 55 per dollar at present.

During October, CPI-based rate in US stood at 2.2%, against 9.75% in India.

According to Deepak Mohanty, executive director, RBI, if persists beyond the threshold level of 4-5.5% level, it could lower economic growth over the medium-term. In his paper titled, 'Threshold in India: An Empirical Investigation', he said prolonged high inflation, even if originating from the supply side, could give rise to increased expectations and cause general prices to rise.

As is inimical to growth, it becomes necessary for monetary policy to respond to contain and anchor inflationary expectations.

Agreeing with Reddy, Madan Sabnavis, chief economist, CARE Ratings, said that the normal cannot be 4-5% given the fuel price hike, a 10-15% Minimum Support Price increase by the government annually, supply constraints among other things. 

“A target of 6-7% seems more realistic”, he said.

In a country like India where one is still dependent on monsoon for agri produce, can only be reduced in a phased manner in the medium to long run, from 6-7% to 5% and then 4%.

DK Joshi, chief economist, Crisil believed that though a 5% rate is not achievable in the short run, the endeavour in the medium term should be to bring it down to 4-5% mark as high hurts poor the most.

RBI is not reversing its monetary policy stance on the back of inflationary expectations that still persist and has at the same time asked the government to take measures to cut widening

RBI will next meet for policy review on December 18 amid economic growth falling to 5.3%  in the second quarter of this fiscal which matches the rate during the fourth quarter of last fiscal, a three-year low. Not only this, economic growth for the entire fiscal is headed for 10-year low.

Though the target should be to bring down to 4-5%, but at around 7% can make a case for a rate cut by RBI, said Anis Chakravarty, senior director, Deloitte India.

has seen different thresholds suggested by different committees and economists. In a report on reviewing the working of the monetary system, Sukhamoy Chakarvarty Committee (1985) suggested threshold to be 4%. Rangarajan, in 1998, called 6-7% as acceptable. A Samantaraya and A Prasad in 2001 found the threshold level to be around 6.5%. A more recent study by P Singh (2010), who used both yearly and quarterly data, found threshold level of at six% in India. End

First Published: Tue, December 04 2012. 17:53 IST