India adopts an inflation target

India adopted an inflation target of 4% for next five years under the monetary policy framework as previously agreed and in line with the Centre's focus on macroeconomic stability to boost growth while keeping prices in check.
The finance ministry has notified the consumer inflation target for RBI until March 31, 2021, with an upper tolerance level of 6% and lower limit of 2% that was finalised in consultation with Governor Raghuram Rajan, whose term ends next month. This prepares the ground for setting up Monetary Policy Committee that will set rates in keeping with this target.RBI currently sets the rate. “Fixation of an inflation target while giving due emphasis to the objective of growth and challenges of an increasingly complex economy is an important monetary policy reform,“ the finance ministry said in a release on Friday . Inflation based on the consumer price index (CPI) in June was at 5.77%, close to the upper end of the band, which all but rules out a reduction in rates in the near term. The next monetary policy review is set for August 9, the last that will be overseen by Rajan.
The decision means there's no change in the target included in the monetary policy framework agreement between the government and RBI in February last year -4% with a range of +-2%.
When the Reserve Bank of India fails to meet the inflation target, it will send a report to the central government stating reasons and remedial actions that will be taken. A breach of the “tolerance level“ for three consecutive quarters will constitute a failure of monetary policy . There had been some speculation about a higher inflation target being prescribed to create room for a reduction in interest rates to boost growth. Former RBI governor C Rangarajan said the monetary policy framework was appropriate.
“I have always maintained that the dominant objective of monetary policy is price stability and it is through price stability it plays a role in growth augmentation,“ he said. “This target is not very rigid as even up to 6% harsh measures may not be needed.“
Economists welcomed the government's adherence to the informally agreed number. The finance ministry said the advantage of having a band is that it allows the MPC to recognise the short-run tradeoffs between inflation and growth but enables it to rein in prices in the long run and over the course of business cycles.
The range also accommodates data limitations, projection errors, shortrun supply gaps and instability in agriculture production, an important factor for CPI inflation. Food articles account for a major weight in the indices.
The earlier agreement, in the form of a memorandum of understanding, has now been given statutory backing with the latest notification by an amendment to the RBI Act. The amendment lays down that the central government will, in consultation with RBI, determine the inflation target once every five years.
Balancing growth with price stability has previously led to conflict between RBI and the government, which usually wants lower interest rates that can provide a lift to the economy . 

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