Explained: How headline number won the debate on inflation targeting

Which to make the benchmark inflation rate — the core retail figure or the headline number — was the subject of considerable cut and thrust before the government threw in its lot with the latter as the reference for the central bank’s inflation targeting policy.
 
Both the Reserve Bank of India (RBI) and the finance ministry had deliberated on making the core retail figure the benchmark for inflation targeting. However, they chose headline inflation because it worked well in the previous five years.
 
Core inflation refers to inflation with price rise in fuels and food items left out. Headline inflation refers to overall price rise.
 
“It would have been better to target core inflation in the new framework. However, they did not want to change. There is rationale in both,” said a key official in the finance ministry.
 
The finance ministry decided to keep the retail inflation target at 4 per cent, give or take 2 per cent, from the current financial year -- the same as the case in the previous five years.
 
Many economists say core inflation should either be made the main inflation target or be kept as an additional target.

 
Former chief statistician Pronab Sen said the current framework was fine.
 
“I don’t want headline inflation to be the only target in a country like India. I would prefer a second target, which would be the core,” he said.
 
Sen, who is now India programme director for the International Growth Centre (IGC), said core inflation should be targeted at 3 per cent, plus or minus 1 per cent.
 
“When you have monsoon failure, taking decisions on the basis of headline inflation would be wrong because monsoon failure is a contractionary event. If on top of that if you add further contractionary interest rates, you are becoming pro-cyclical, while you need counter-cyclical policies during such times,” he said.
 
If food prices are rising because income distribution has improved, then you need to temper that, he said.
 
“You have to choose which target to follow at any given time. It should be left to the Monetary Policy Committee (of the RBI) to decide on this. It should not have its hands tied by the law,” Sen said.
 
Earlier, the RBI had come up in support of the existing inflation target, saying that any further loosening would undermine the central bank’s ability to frame monetary policies.
 
“The current numerical framework for defining price stability, i.e. an inflation target of 4 per cent with a +/-2 per cent tolerance band, is appropriate for the next five years,” the Reserve Bank had said in a report released in February.
 
Interest rates on small savings
 
These have to be market-determined because otherwise the government will have to provide subsidy, which does not make sense, the official said.
 
“We compare ourselves with advanced economies on many matters. In advanced economies such as the US, the rate of fixed deposits is nothing. The same is the case in Europe, Japan, etc. Overall in the past 25 years, there has been a decline in interest rates across the globe, so in the market economy you have to expect market price,” he said.
 
The ministry had earlier lowered interest rates on small savings, but reversed the move a day later, calling it an “oversight”.
 
GDP projections
 
The official said there would not be any change in projection of 11.5 per cent economic growth for the current financial year, done by the Economic Survey. “Ours is more conservative than revised projections by the IMF and the OECD,” he said.
 
The IMF has projected India’s economy to grow 12.5 per cent and OECD by 12.6 per cent during FY22.
 
On the fall in GDP by 1.1 per cent, projected by the second advance estimates for the fourth quarter of the previous financial year, the official said gross value added (GVA) was a better measure than GDP, because the latter was GVA plus taxes on subsidy.