A question of compliance

Source: Business Standard

Relevance: Inflation Targeting is the main tool of fighting inflation.

Synopsis: More transparency and clarity are required over RBI’s way of managing inflation.

Introduction:

• RBI has recently released minutes of the RBI Monetary Policy Committee’s meeting.
• It decided to retain the prevailing repo rate at 4 per cent and continue with the accommodative stance to revive growth and continue to mitigate the impact of Covid-19 on the economy.
• RBI has prioritized growth over inflation.

Why such a move of RBI is the cause of concern?

• Firstly, there is no clarity over what happens if these inflation projections go wrong.
  • The June retail inflation number will have to decline to around 5 per cent to be in line with the projections, which is difficult.
  • Also, Localised lockdown in different parts of the country is not fully reflected in retail inflation.
• Secondly, it raises question over Committee’s compliance of inflation targeting regime.
  • As per compliance provision, average inflation above 6 per cent for any three consecutive quarters means a failure to achieve the inflation target.
  • RBI must submit a report to the Union government stating the reasons for failure, remedial actions, and an estimate of the time within which the inflation target should be achieved.
• Thirdly, when retail inflation exceeded the upper tolerance band from March 2020 to December 2020, there was no such report from the RBI.
  • Monetary Policy Committee had noted that data for April and May 2020 were collected under the limitations of the lockdown.
  • The government had clarified that it was due to short-run supply gaps and instability in agriculture production.
• Lastly, the break in the CPI series is questionable.
  • The tolerance band is expected to allow the MPC to recognize the short-run trade-offs between inflation and growth and enable it to pursue the inflation target in the long run.
  • It implies that the tolerance band was not able to handle data limitations.

It shows the Committee had taken the easy way out by not explaining to the government what its perspective was on inflation. Also, the government failed to secure from the RBI a report on inflation.

Way forward:

• Compliance report should be presented as it brings attention back to the need for reining in inflation.
• It helps to generate a public debate on the vital issue affecting the people.
• It also helps the government explore policy options to limit the impact of higher prices on its citizens.

Hence, RBI should soon return to its primary mandate of adhering to the inflation target of 4 per cent with a permissible upper tolerance level.