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Inflation fight caught in debate over role of RBI

Mumbai, March 21: Reserve Bank of India governor Raghuram Rajan today said the central bank had not yet started inflation targeting as it was still engaged in discussions with the Union government on what appeared to be a sensitive issue as it raised serious questions about the RBI’s mandate.

The RBI and Rajan believe that the sole objective of India’s monetary policy should be to bring down inflation.

Finance minister P. Chidambaram, however, believes that the RBI, like the US Federal Reserve, should have a dual mandate: bring down inflation and spur economic growth.

In the case of the US Fed, the mandate is to “maintain long run growth of the monetary and credit aggregates commensurate with the economy’s long run potential to increase production.” The so-called dual mandate is linked to the goals of ensuring “maximum employment, stable prices and moderate long-term interest rates”.

The US Fed has spelt out that its long-term goals will be to hold inflation below 2 per cent and bring down the rate of unemployment — which is the proxy measure for economic growth — to under 6 per cent. While inflation remains under 2 per cent, unemployment in the US is currently riding at 6.7 per cent.

Rajan reiterated that the RBI would closely look at retail inflation number, which is currently at 8.1 per cent, and its objective would be to bring it down.

“We haven’t moved into inflation targeting as yet. That’s something the Urjit Patel committee suggested, and it is not something the RBI has accepted,” Rajan said while delivering his keynote address at the convocation of the Indira Gandhi Institute for Development Research here today.

It may be recalled that the Urjit Patel panel, which submitted its report in January, had recommended that inflation should be the nominal anchor for the monetary policy framework and this should be set by the RBI as the predominant objective of the monetary policy in its policy statements.

The committee also said the central bank should track the retail inflation number instead of wholesale prices since it felt that the true inflation that consumers faced was in the retail market.

It further recommended a path or a target zone wherein the retail inflation should be brought down

to 8 per cent within a year and to 6 per cent at the end of the second year. This is before formally adopting the recommended long-run target of 4 per cent with a band of +/-2 per cent.

The Urjit Patel recommendations have caused some discomfiture at the North Block where it is feared that the focus on controlling retail inflation could result in interest rates staying high, which would hamper economic recovery.

Since the release of the report, the RBI has been in talks with the finance ministry on having retail inflation as the nominal anchor and other matters such as the formation and composition of a monetary policy committee, which will have the responsibility of achieving a pre-determined inflation target.

In fact, after the release of the report, the RBI had a nasty surprise for the markets when it raised the repo rate by 25 basis points to tackle retail inflation. With CPI inflation falling to 8.10 per cent in February from 8.79 per cent in the preceding month, it is now expected that the RBI will opt for status quo when it reviews its monetary policy on April 1.

“We are exploring the recommendations of the Urjit Patel report, and there are some aspects of it which have to be discussed with the government. We have to explore some of these aspects with the government, including the setting up of a monetary policy committee including what, if any, the inflation target will be,” Rajan added.

Rajan admitted that the central bank should focus on CPI rather than WPI. “We need to bring the CPI down. We need to bring it down to is 8 per cent by the end of this year and 6 per cent by the end of the second year,” the RBI governor added.

 
 
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