Inflation targeting has worked, but now needs fine-tuning, say economists

Economists at the BS BFSI Summit said India's inflation-targeting framework has anchored expectations and strengthened RBI's credibility, but needs more flexibility and stronger policy coordination

Ten years after India adopted the inflation-targeting framework, economists in India broadly agree that it has served the economy well by anchoring expectations and strengthening the Reserve Bank of India’s (RBI) credibility. Speaking at the Business Standard BFSI Summit in Mumbai, the panellists said the framework had largely achieved its objectives but now needed nuanced reforms rather than a redesign.

 

Chetan Ghate, professor of economics at the Indian Statistical Institute, said inflation targeting “has to be judged in terms of establishing a credible nominal anchor”. Before its introduction, the RBI “was looking at lots of different indicators and markets didn’t understand where it would go.” The framework, he said, has given markets a clearer signal and raised the “credibility premium” of the central bank.

 

Ghate pointed out that bond yields and key macro indicators had responded positively and “headline inflation has, by and large, converged towards the core.” He said, “After ten years, it has by and large been a success. It doesn’t at the current juncture need a major rethink.”

 

Answering a question on should the RBI now target core inflation rather than headline, Ghate said the RBI’s own research had explored whether targeting core inflation might be more effective since headline inflation is volatile. However, he noted, “many academic papers now show core inflation moving towards the trajectory of headline inflation,” suggesting the relationship had reversed.  ALSO READ| India needs bigger, more global-scale banks for 2047 goal: Banking leaders

 

However, Ashima Goyal, emeritus professor of economics at the Indira Gandhi Institute for Development Research, disagreed. “You need to stick with headline inflation because it concerns the main welfare of people,” she said. Goyal argued that while inflation targeting had worked, “there is a perceptible fall in inflation.” 

 

“The answer is not to move away from inflation targeting,” she said, “but to make it flexible.” Goyal called for improvements in forecasting, liquidity management, and coordination between fiscal and monetary authorities.

 

Speaking on how flexible the framework should be, Janak Raj, senior fellow at the Centre for Social and Economic Progress and a former RBI official, said the flexible targeting regime introduced in October 2016 had brought clarity and balance. “Till 2019, average inflation was about 4 per cent, close to the target. Then came Covid, the Russia-Ukraine war, and supply shocks,” he said. “The RBI decided to miss the target to support growth.”

 

Raj added that flexibility had helped manage growth and external pressures and argued “there is no reason to put down the inflation target,” though the tolerance band could be reviewed if inflation stayed low for extended periods.

 

Expanding on this, Mridul Kumar Saggar, professor of practice at IIM Kozhikode, said India’s inflation-targeting journey could be divided into three distinct phases. “We disinflated the economy when we introduced inflation targeting. Inflation was around 10-11 per cent after the global financial crisis, and we brought it down and kept near our target till 2019,” he said. “Not many countries can boast of such success.”

 

Saggar noted that after this phase came the supply-side shocks. “Inflation surpassed the target. There were a series of breaches due to pandemic and Russia-Ukraine war. We were conscious that extraordinary circumstances would need to save lives, save jobs. Even during Covid, ours was a success to some extent,” he said.

 

The panellists agreed that the current structure of the Monetary Policy Committee (MPC) has worked, though the debate on the RBI governor’s veto power continues.

 

Goyal said veto power should remain but discussions within the MPC “need to be more open.” Raj noted that every input on monetary policy is already public, while Saggar warned against removing the veto without first giving external members full-time institutional backing and access to data. “If we don’t do that,” he said, “the change would be counterproductive.”