The Indian government's targeting of inflation at 4% with a range of plus/minus 2% is a "credit positive" measure that will help macroeconomic stability, Moody's Investors Service said on Sunday.
"The Indian government's notification of the inflation target at 4%, plus or minus 2% through to 2021 is a credit positive re-affirmation of commitment to keeping inflation at moderate levels," said Moody's Senior Vice President (Sovereign Risk Group) Marie Diron in a statement.
"Sustained moderate inflation would contribute to macroeconomic stability and help prevent a repetition of the short marked cycles of the past," Diron said.
"An explicit inflation target can help anchor inflation expectations and hence actual inflation at moderate levels. At a time when large increases in wages are implemented in the public sector, moderate inflation expectations could help prevent spillovers to wage and price settings in other sectors," Diron said.
The inflation target until March 31, 2021, was notified by the central government on Friday in consultation with the Reserve Bank of India (RBI).
The government stated that the inflation target will be considered a failure if the average inflation is more than the upper limit of 6% or below the lower level of 2% for three consecutive quarters.
If the RBI fails to meet the inflation target, it will need to state the reasons for failure to the Centre in a report along with the remedial actions proposed to be taken and an estimate of the time-period within which the inflation target shall be achieved, according to the Finance Bill 2016.
The changes to the monetary policy regime of the last two years mark a step towards greater policy transparency and predictability, both of which should help in policy transmission and hence monetary policy effectiveness, Diron said.
The setting of the inflation target comes under the monetary policy framework agreement between the government and the RBI signed in early 2015. The central government in consultation with RBI will henceforth determine the inflation target in terms of the Consumer Price Index (CPI) inflation or retail inflation, once in every five years.
According to the agreement, the RBI will once in every six months publish a document to be called the Monetary Policy Report, explaining the sources of inflation and the forecasts of inflation for the period between next six to eighteen months.
The government has started the process of setting up a Monetary Policy Committee (MPC), which would be mandated to set the interest rate, a practice now being carried out by the RBI.
The central bank will need to provide all information to the members of the Monetary Policy Committee that may be relevant in achieving the inflation target.