Inflation must be RBI's priority with strict vigil, oversight assured

The Reserve Bank of India (RBI) has done well to initiate a discussion paper to review its inflation-targeting framework, seeking feedback on key aspects ahead of the mandatory second five-year review in March 2026. Notably, no such public consultation was held during the first five-year review in 2021. That said, the discussion paper should have been issued by the government, as the responsibility for resetting the target lies with the government under the RBI Act. 

 

Many experts and economists have since expressed their views on different aspects of the discussion paper. On the issue of headline versus core inflation targeting, there is much commentary, including a poll by this newspaper, favouring the headline inflation target, with an appropriate tweaking of the weightings of different constituents of the consumer price index (CPI) basket. On the other issues too, the majority view seems to favour maintaining the status quo.

 

The RBI performs multifarious functions, some of which are, in fact, conflicting. It isn’t easy to spell out the KPIs (key performance indicators) to judge its performance objectively. The objective of amending the RBI Act in 2016 was to make the RBI focus on containing inflation, make it accountable for achieving this objective, and bring in transparency in deciding the repo rate. 

 

The framework has worked reasonably well, with the Monetary Policy Committee (MPC) doing a decent job. After each MPC meeting, the RBI has been eloquent in explaining its position, besides making inflation and growth projections. The minutes of MPC proceedings, giving views expressed by each of the members, are published a fortnight after each meeting. 

 

One of the issues which often keeps coming up is about giving flexibility to the RBI in meeting its statutory mandate. It essentially flows from the “price stability versus economic growth” debate. Both “price stability” and “economic growth” are desirable aims. However, what needs to be appreciated is that while the economic growth benefits get unevenly distributed among different strata due to high per capita income inequality and other factors, surely the price rise has a much more adverse impact on poor people and the unorganised sectors. 

 

Thus, price stability needs to be given primacy. The reason this task is entrusted to the central bank is that it may be difficult for an elected government to take an objective and timely decision on interest rates. Admittedly, fiscal policy and other government actions play a crucial role. Ideally, both monetary and fiscal policies need to move in a coordinated way, thereby reinforcing each other, to achieve optimal results.  Unfortunately, that may not always be the case. In such situations, attempting to achieve something through monetary policy, which is in the domain of fiscal policy, would be counterproductive. Not only should the central bank stick to its “dharma” at all times, it should also be seen adhering to it.   

 

The two questions in the RBI’s discussion paper, viz, (i) should the tolerance band of (+/-) 2 per cent be adjusted, and (ii) should the point target of 4 per cent give way to a more flexible range, should be examined against this backdrop.

 

The existing tolerance band of (+/-) 2 per cent around the 4 per cent inflation target might have been justified in 2016, when we were embarking on the new practice of mandating inflation targeting for the central bank. It ought to be narrowed while reviewing the framework in 2026. The existing band is like keeping the window wider than the door. Similarly, the point target should be retained, instead of adopting a flexible range, so that the central bank’s attention is not diverted from its mandate to keep a check on inflation. 

During the last nine years, after the 2016 RBI Act amendment, one of the contentious issues has been the RBI’s inability to keep headline inflation below 6 per cent for a substantial period. For instance, between December 2019 and August 2023, the CPI-based inflation rate was above 6 per cent in 26 out of 44 months. For quite some time in the post-Covid period, the RBI maintained that the increase in inflation was transitory. This was later explained as being caused by supply-side constraints, with the argument that monetary policy is not the right tool to address the issue. There may be some merit in this argument. But then, what is the way forward to deal with such situations in future, where bringing monetary policy changes alone might not help? This isn’t a theoretical proposition. The global uncertainties, the dismantling of post-world war II institutions, and rising protectionism only increase the probability of such possibilities. 

 

Section 45ZN of the RBI Act, 1934, mandates that the RBI submit a report to the government if it fails to keep average inflation below 6 per cent over the preceding three quarters. The report should contain the reasons for failing to achieve the inflation target, the remedial actions proposed by the Bank, and an estimate of the time period within which the target will be achieved following timely implementation of these measures. The RBI did submit such a report to the government in November 2022. What does that report say, and what action has the government taken on it? Is there any need or justification for providing an escape clause for not meeting the target in such situations? This must be carefully analysed and an informed decision taken.

 

While answering a Lok Sabha question in December 2022 on the “breach of the inflation target”, seeking inter-alia information whether the government proposes to make the RBI’s report public, the government replied that the provisions of the RBI Act, 1934, and regulations therein do not provide for making the report public.

 

The fact that the law is silent on what the government should do with the report has been quoted as the reason for not making the report public. This could hardly be an argument. Why should the government shy away from making the report public? In fact, this report should be examined by the standing parliamentary committee of the finance ministry and be deliberated upon in Parliament. No harm in letting more sunlight come in!

 

In conclusion, the RBI should continue to maintain a strict vigil over inflation, with parliamentary oversight ensuring its accountability in meeting this objective. 

 

The author is a distinguished fellow at the Observer Research Foundation, a former Sebi chairman, and a former IAS officer