RBI meets its first inflation target

If the target is missed for 3 consecutive quarters, RBI will have to give an explanation to the govt

The Reserve Bank of India (RBI)'s new monetary policy framework received a shot in the arm on Friday, after the January 2016 target for Consumer Price Index (CPI)-based inflation came within the central bank's September 2014 predictions - below six per cent.

The January reading for retail inflation came at 5.69 per cent, higher than December's 5.61 per cent, but well within what the central bank's monetary policy framework had envisaged. This was the first target of the framework that was met. The next informal target is five per cent by January 2017. The eventual target is to maintain retail inflation at four per cent from 2016-17, within a band of +/- 2 per cent. If the target is missed for three consecutive quarters, RBI will have to give an explanation to the government.

This and the new liquidity framework that targets a price-based regime are the new exercises the central bank has embarked upon. These steps indicate a major shift in the philosophy of RBI, which used to mostly take steps that were reactionary. But now the central bank was working on a proactive basis, analysts said.

Under its new liquidity framework, it no longer matters how much liquidity RBI pumps into the system. What matters now is whether that liquidity has kept the overnight call money rate firmly anchored in and around the operative policy rate - in this case, repurchase, or repo rate of 6.75 per cent.

"By avoiding many outright open market operations (OMOs), RBI is not adding liquidity on a durable basis and thus they are not printing money like in the earlier regime. They are not monetising deficits and that is definitely a paradigm shift in philosophy," said Rupa Rege Nitsure, group chief economist, L&T Finance.

Banks might not have to struggle for liquidity, but would have to be disciplined with their liquidity balance so that they can raise or deposit money through the three liquidity auctions every day at a rate close to the policy rates. This would ensure banks focus more carefully on their asset-liability mismatch.

Under this liquidity regime, the central bank is conducting auctions under OMOs for secondary market bond purchases, but at the same time, going beyond public OMOs to buy bonds directly from the market, as reported by Business Standard on February 1.