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Maintaining inflation target at 4% appropriate for India: RBI paper

29 Dec 2020 Evaluate

Reserve Bank of India (RBI) paper has said that maintaining the inflation target at 4 percent is appropriate for India as targeting a lower rate could impart deflationary bias to the monetary policy. It said under the current dispensation, the RBI has been mandated by the government to maintain retail inflation at 4 percent with a margin of 2 percent on either side.

The paper, authored by RBI Deputy Governor Michael Debabrata Patra and another official Harendra Kumar Behera, has found a steady decline in trend inflation to 4.1-4.3 percent since 2014. It also noted that a target set too below the trend imparts a deflationary bias to monetary policy because it will go into overkill relative to what the economy can intrinsically bear in order to achieve the target. Analogously, it said a target that is fixed above-trend renders monetary policy too expansionary and prone to inflationary shocks and unanchored expectations. The paper notes that estimating trend inflation with regular updates is important for the formulation of monetary policy, irrespective of the country setting.

In a bid to keep inflation under specified level, the government in 2016 had decided to set up Monetary Policy Committee headed by the RBI Governor entrusted with the task of fixing the benchmark policy rate (repo rate). The six-member panel, which had its first meeting in October 2016, was given the mandate to maintain annual inflation at 4 percent until March 31, 2021, with an upper tolerance of 6 percent and lower tolerance of 2 percent.

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