India to Target Inflation

India’s economy has been growing steadily for quite a few years. Along with high growth comes inevitable inflation. In response, Indian policymakers have decided on a new strategy to target inflation as they gear up for even stronger growth in coming years.

The new policy, dated February 20, indicates that the government will target inflation growth to 4 percent, with room for variance of plus or minus 2 percent. The policy also directs the Reserve Bank of India (RBI) to bring inflation below 6 percent by January 2016. 

India’s economy has been growing steadily for quite a few years. Along with high growth comes inevitable inflation. In response, Indian policymakers have decided on a new strategy to target inflation as they gear up for even stronger growth in coming years.

The new policy, dated February 20, indicates that the government will target inflation growth to 4 percent, with room for variance of plus or minus 2 percent. The policy also directs the Reserve Bank of India (RBI) to bring inflation below 6 percent by January 2016. 

The RBI, under the leadership of Governor Raghuram Rajan, has championed inflation targeting since 2013. The target of band of 2 to 6 percent inflation is the same as a proposal set forth by the RBI in January 2014. 

The idea of inflation targeting is not original to India. New Zealand pioneered this in the 1990s, and now a number of central banks in Europe, the emerging markets, and even the US Federal Reserve follow this concept. Typically, an explicit target for inflation is determined and made public. This allows the central bank to set policies in line with achieving that goal. 

These new policies for India represent a major change in the Indian system of central banking, which has existed since 1935. The Indian Finance Ministry has indicated that it is their goal to modernize the policy framework of its reserve banking system while maintaining price stability and maintaining (or even accelerating) India’s economic growth. 

The new agreement also sets forth a number of new duties for the RBI. Examples include the requirement to generate detailed reports identifying sources of inflation every 6 months. The same reports shall also contain inflation forecasts for a 6 to 18 month horizon. Should the RBI fail to meet its target for inflation, it shall be required to prepare an additional report explaining why it failed and suggesting remedial actions (including periods for action items) designed to correct the situation.

Some analysts believe India’s recently accelerating inflation spurred the move, which grew from 4.28 percent in December to 5.11 percent in January. Meanwhile, India’s GDP grew 7.5 percent in 2014. While these new policies may reign in India’s explosive growth to some extent, the stabilizing effect should prevent runaway inflation and the boom/bust cycles of unregulated economies.

India’s Finance Minister also proposed setting up a monetary oversight committee within the Indian government during a speech given February 28 to announce the new inflation policies. However, the policies themselves contain no mention of such a committee.