The flexible inflation targeting (FIT) framework as monetary policy architecture has been adopted mandating the Reserve Bank of India (RBI) to monitor the movement of CPI-led inflation within a band of 4%, +/-2%. Effectively, the RBI moulds the direction of its monetary policy to ensure that inflation remains within a range of 2% on the lower edge and at 6% on the upper end.
Adoption of FIT puts India among the league of global economies such as the US, the UK, Canada, Japan and New Zealand which have been following the policy to target a defined range of inflation to ensure price stability and growth. Thus, with the formal institution of FIT in September 2016, India became the 36th country to adopt an inflation-targeting monetary policy regime.
In the long term, moderation of inflation can be an effective tool to build an ecosystem to ensure sustained growth while assuaging people’s sufferings at the grassroots level whose livelihood is sensitive to price movements of commodities. Moving towards the FIT trajectory is one of the global best practices to shape assured development, balancing growth and volatility of price dynamics.
The validity of the FIT inflation benchmark ended on March 31, 2021. Maintaining continuity of policy, as expected and in line with a central bank study, the government retained the same range of inflation target for another five years till March 31, 2026, providing a clear forward direction to the mandarins of the economy.
The ‘Report on Currency and Finance – 2020-21’ of the RBI evaluated the level of inflation target, and the tolerance band around it from the point of its appropriateness in evolving macroeconomic and financial conditions. There were also intense debates, discussions and cross-section of views on the range of inflation target, more importantly considering the crisis-ridden convalescing state of the economy.
Genesis of FIT
The inflation experience of the immediate post global financial crisis years were daunting when it surged from 3.8% in 2009-10 to 9.6% in 2010-11. Following such a spurt, an expert committee was appointed in September 2013 to revise the monetary policy framework within a five-pillar approach comprising:
- Clarifying and strengthening the monetary policy framework
- Strengthening the banking structure
- Broadening and deepening financial markets
- Fostering financial inclusion
- Improving the system’s ability to deal with financial stress
The recommendations of this committee on the choice of a nominal anchor for monetary policy, decision making, instruments and operating procedure, transmission and open economy monetary policy provided the intellectual basis for coming up with the FIT model to rein in inflation.
The RBI, accordingly, announced a disinflationary glide path for bringing down CPI inflation to 8% by January 2015 and to 6% by January 2016. Inflation fell in line — 5.2% in January 2015 and 5.7% in January 2016. In terms of resolution in the Union Budget 2016-17, the RBI Act, 1934, was amended to provide statutory basis for a Monetary Policy Framework and a Monetary Policy Committee was institutionalised through the Finance Bill 2016.
It led to the adoption of FIT, fixing the inflation target for the period from August 5, 2016, to March 31, 2021, as 4%, with the upper tolerance level of 6% and lower tolerance level of 2%. The RBI has to submit a report with reasons for breaching the inflation target, if it is beyond 6% for two consecutive quarters. Fixation of an inflation target while giving due emphasis to the objective of growth and challenges of an increasingly complex economy is an important monetary policy reform with necessary statutory back-up.
Impact of FIT
The strategic policy transformation brought in with the adoption of FIT led to the lowering of average inflation from October 2016 to March 2020. It is heartening to observe that inflation fell from a high of 9% before FIT to a range of 3.8-4.3% during FIT. Apart from aligning inflation with the target, it provided near certainty to the people about the course of future inflation by minimising its fluctuations. This is the crux of price stability.
The pre-FIT, CPI inflation during the period 2012-16 averaged 7.5% while post FIT period 2016-20 recorded a considerable decline to 4.1%, affirming the effective impact of FIT. At the same time, it did significantly impact the GDP trajectory that stayed at 6.8% during 2012-16 and 6.4% during 2016-20, further convincing that inflation focus did not douse growth sentiments. It is after the onset of the pandemic that inflation surged past its threshold to touch 6.03% in June 2020 to reach 7.35% in December 2020 due to steep volatility in food inflation and supply-side disruptions. It again softened to 5.03% in February 2021 and is back to the FIT range.
With the transparency of the FIT policy stance for the next five years, trade, industry and global investors will be able to comprehend the policy basis of the monetary policy and can tune their business blueprint keeping the expected shape of inflation headwinds.
Since inflation touches every stakeholder, more importantly, the people at the bottom of the pyramid, the statutory onus to regulate its pathway can enhance price stability to accelerate potential growth with assured range-bound input costs. Keeping inflation at its epicentre of monetary policy dispensation can be an indicative assurance that it will not be allowed to go awry. Looking at the merits of the FIT policy and its contribution of the last five years in taming the inflation trajectory, continuity of the band will be in the farsighted interest of the economy.
Even in the midst of uncertainty and looming geopolitical risks, the intent to rein in the prices of essential commodities in a developing economy is tantamount to accepting a daunting challenge in the interest of society.
(The author is former General Manager, Strategic Planning, Bank of Baroda. Views are personal)
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