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10
1 Introduction
n January 2014, the Urjit Patel Committee report proposed a new framework for monetary policy flexible
inflation targeting (FIT). Several arguments were made in justification of a
change from the previous, multipleindicator1 based structure, chiefly in response to its perceived failure and credibility loss from the inability to control
elevated, persistent inflation for some
years (para II.17, p 9, Report of the Expert
Committee to Revise and Strengthen the
Monetary Policy Framework, Chairman:
Urjit Patel; hereafter has referred as
UPC). While a formal adoption of the new
framework is being discussed with the
government, the Reserve Bank of India
(RBI) has accepted one of its key recommendations, viz, shifting over to consumer price inflation (consumer price
index, CPI) as the clearly defined nominal
anchor and adoption of a two-year glide
path to prepare the initial conditions
ahead of formal adoption.
Inflation targeting (IT) as a macroeconomic policy tool is now more than
two decades old, with varied country experience. It is distinguished by an explicit central bank mandate to pursue
price stability as the primary monetary
policy objective and a high degree of operational autonomy; explicit quantitative
targets for inflation; central bank accountability for performance in achieving the
inflation objective mainly through hightransparency requirements for policy
strategy and implementation; and a policy
approach based on forward-looking assessment of inflation pressures, incorporating
a wide array of information (Roger 2010).
The central bank publicly announces a
projected, or target inflation rate and
then endeavours to guide actual inflation
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COMMENTARY
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CPI
10
Core CPI
8
Policy rate
6
4
WPI
10-year bond yield
2
1
1/2012
4/2012
7/2012
10/2012
1/2013
Source: CSO, RBI and authors calculations.
4/2013
7/2013
10/2013
1/2014
4/2014
7/2014
10/2014
2008-09
2009-10
2010-11
2011-12
2012-13
2013-14
GDP
(in %)
Fiscal Deficit
(Centre) 1
Current
Account1
Inflation2
Interest
Rates3
6.7
8.6
8.9
6.7
4.5
4.7
6.0
6.5
4.8
5.7
4.9
4.6
-2.3
-2.8
-2.8
-4.2
-4.7
-1.7
8.3
10.9
12.1
8.9
9.7
10.1
8.0
4.9
5.5
7.6
8.1
8
Net
Net Intl
Forex
Capital ac1 Invt Position1 Reserves1
0.6
3.8
3.7
3.6
4.8
2.6
-5.1
-11.6
-12.8
-13.2
-17.3
-17.7
13.8
18.3
16.1
14.1
9.8
9.0
Import
Cover4
9.8
11.1
9.5
7.1
7
7.8
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COMMENTARY
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COMMENTARY
Indeed, the fiscal past is ridden by abandonment or pause of rules each time the
business cycle wanes, growth slows and
revenues decline. For instance, a pause
was announced in 2009-10 to combat
the crisis shock and return to the path
laid out under the Fiscal Responsibility
and Budget Management Act was delayed.
A new fiscal consolidation path was
drawn by the Kelkar panel in late-2012
to restore the health of public balances
by 2016-17; this was adopted with the
government on course to achieve this
since last quarter of 2012.
However, history seems set for repetition once more with the current public
discourse favouring a pause to the revised
fiscal consolidation path for accommodating growth concerns: With growth
recovery elusive, there is emerging consensus and advocacy for fiscal pumppriming: the governments recent MidTerm Review suggests that public expenditure replace the private business spending vacuum and kick-start growth; and
there is indication that the ongoing fiscal
consolidation road map may be revised,
modified or replaced to incorporate
countercyclical elements. The risk from
such political responses to the business
cycle in undermining the RBIs credibility
as also of the new framework is quite high.
Then again, while institutional support
by way of tight fiscal rules would be required in the next stages of FIT, the required fiscal path could be quite demanding given current growth conditions and
medium-term outlook. This directly
brings into focus the macroeconomic
timing of the transition. Unless growth
picks up quite substantially to relieve the
fiscal burden and relaxes budgetary constraints, there could be political temptation to delay or breach fiscal targets; or
political support for FIT could be weak.
Exchange Rate Fluctuations and the
Nominal Anchor: Exchange rate stability
is a key element in stabilising CPI inflation,
particularly in EMEs. Exchange rate fluctuations cannot be altogether ignored,
especially depreciations that lead to a
rise in inflation from pass-through of
higher import prices and greater export
demand, besides detrimental effects of
dollarised liabilities and vulnerability of
Economic & Political Weekly
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COMMENTARY
14
major reductions in inflation rates and improvements in average growth rates; although nonIT countries continued to have lower inflation
and higher growth than IT ones, the latter saw
larger improvements in performance. (ii) Both
groups also experienced large reductions in inflation-output volatility, but IT-countries registered bigger declines, especially in inflation
volatility. (iii) Among high-income economies,
little change in performance occurred in the
IT-countries on average in these two periods,
whereas the non-IT set typically experienced a
decline in growth; likewise, the former group
experiences little change in output or inflation
volatility between the two periods, but output
volatility was higher in the non-IT group.
References
Banerjee, Ryan, Stephen Cecchetti and Boris Hofmann (2013): Flexible Inflation Targeting:
Performance and Challenges in Lucrezia Reichlin and Richard Baldwin (ed.), Is Inflation
Targeting Dead? Central Banking after the Crisis,
Centre for Economic Policy Research: 118-25.
http://www.voxeu.org/sites/default/files/file/
P248%20inflation%20targeting.pdf
Fischer, Stanley (2001): Exchange Rate Regimes:
Is the Bipolar View Correct?, Distinguished
Lecture on Economics in Government American
Economic Association and the Society of Government Economists Delivered at the Meetings
of the American Economic Association New Orleans, 6 January, available at https://www.imf.
org/external/np/speeches/2001/ 010601a.htm
Friedman, Milton, ed. (1956): Studies in the Quantity Theory of Money (Chicago: University of
Chicago Press).
Jahan, Sarwat (2012): Inflation Targeting: Holding the Line, Finance & Development, http://
www.imf.org/external/pubs/ft/fandd/basics/
target.htm
Kydland, F E and E C Prescott (1977): Rules Rather
Than Discretion: The Inconsistency of Optimal
Plans, Journal of Political Economy, 85(3):
473-92.
Mishkin, Frederic (2004): Can Inflation Targeting
Work in Emerging Market Countries?, NBER
Working Paper No 10646, NBER, Cambridge,
Massuchusetts.
Obstfeld, Maurice (2013): Never Say Never:
Commentary on a Policymakers Reflections,
14th Jacques Polak Annual Research Conference,
7-8 November (Washington: IMF).
Reserve Bank of India (2014): Report of the Expert
Committee to Revise and Strengthen the Monetary Policy Framework, Chairman Urjit Patel,
January.
Roger, Scott (2010): Inflation Targeting Turns 20,
Finance & Development, Vol 47, No 1, pp 46-49.
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