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Sticking to Inflation Targeting Regime

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April 05, 2021

Why in news?

Recently, Centre confirmed that RBI will continue to target the retail inflation within the band of 2% to 6%.

What is the major role of RBI?

  • RBI is the main monetary policy authority for the country, regulator of the banking system and functions as lender of last resort.
  • It sets the benchmark for interest rates and credit growth which can be done in two diametrically opposite ways.
  • If the RBI wants to boost economic growth, it will keep the interest rates lower, relax the regulations for banks to give cheaper new loans.
  • On the other hand, if the RBI wants to maintain financial stability and the control prices, then it would keep a tight control on the interest rates and provisioning of new loans.

What is the odd thing with inflation targeting?

  • Some argue that RBI should focus on the retail core inflation than the retail inflation rate.
  • This is because retail core inflation has fuel and food items whose prices often shoot up in the short-term due to temporary factors —excessive rains or supply side disruption.
  • Thus core inflation is the most robust indicator of the rate of rise in prices.
  • Others can argue that the RBI should look at wholesale inflation.
  • This is because RBI’s move to tweak interest rate affects the credit available to businesses –making loans costlier- which in turn affects the wholesale inflation not retail inflation.
  • Proponents of this view argue that there is a vast gap between the retail and wholesale inflation rates in recent years.
  • Still others say RBI should neither use the above rates as targets but create a Producer Price Index — a more focussed inflation rate index to best suit RBI’s need.

 Why RBI should not focus only on Inflation targeting?

  • RBI has the degrees of freedom in setting the credit policy in the economy.
  • But singular focus on maintaining price stability will be counter-productive for a developing economy such as India.
  • So instead of being overly focusing about the inflation rate, RBI should be work with the government to ensure fast economic growth.
  • These statements have emerged because of India’s decelerating economic growth rate since the start of 2017.

What are the takeaways from this?

  • Earlier RBI Governor stated that there is a clear shift in the RBI’s stance to boost economic growth which is coincided with the economic disruption due to the Covid-19 pandemic.
  • Over the past 12 months, RBI has either relaxed or suspended several regulatory norms for economic growth but the inflation rate has consistently stayed above RBI’s comfort zone.
  • High inflation rate is the most regressive kind of tax as the poor are hit the hardest.
  • And another wave of Covid-induced lockdowns can lead to spike in inflation rates again.
  • Under the circumstances, it is a wise decision by the government to not ask the RBI to give up targeting retail inflation.

 

Source: The Indian Express

 

 

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