Centre sets 4% inflation target for MPC ahead of RBI policy meet

06 Aug 2016


Arun JaitleyIn a departure from existing practice of the Reserve Bank of India governor deciding monetary policy rates, the government has now entrusted the job to a government-designated committee, which also includes the RBI governor.

The government on Friday notified an inflation target of 4 per cent for the next five years, which the proposed Monetary Policy Committee (MPC) of the Reserve Bank of India will have to achieve through its interest-rate setting policies.

Going forward, changes in policy rates will be done by the proposed Monetary Policy Committee (MPC), which will work towards maintaining inflation targets provided by the government.

But, with rising food prices already derailing RBI governor Raghuram Rajan's inflation trajectory and the government announcing a major hike in salaries for central government employees in accordance with the 7th Central Pay Commission's proposals, it seems a difficult target to achieve.

The government wants inflation to be reigned in to levels around 4 per cent for the next five years and the target has to be achieved within a margin of plus or minus 2 per cent, with the upper tolerance level fixed at 6 per cent till 2021, the finance ministry said.

If average inflation is more or even less than the upper or lower tolerance level, for any three consecutive quarters, it would signify a failure to achieve the target.

''Where RBI fails to meet the inflation target... it shall set out a report to the Central Government stating the reasons for failure; remedial actions proposed to be taken; and an estimate of the time-period within which the inflation target shall be achieved,'' the ministry said.

The centre signed a monetary policy framework agreement with the RBI in February last year, where the MPC was to maintain the notified consumer price index-based inflation target.

''The key advantage of a range around a target is that it allows MPC to recognise the short run trade-offs between inflation and growth but enables it to pursue the inflation target in long run over the course of business cycle,'' the finance ministry said.

The Preamble in the RBI Act, as amended by the Finance Act, 2016, now provides that the primary objective of the monetary policy is to maintain price stability, while keeping in mind the objective of growth, and to meet the challenge of an increasingly complex economy. RBI would, accordingly, operate a monetary policy framework.

Out of the six members of MPC, three members will be from the Reserve Bank of India (RBI), including the governor, who will be the ex-officio chairperson, a deputy governor of the RBI and one officer of RBI. The other three members of MPC will be appointed by the central government, on the recommendations of a search-cum-selection committee.

These three members of MPC will be experts in the field of economics or banking or finance or monetary policy and will be appointed for a period of four years and shall not be eligible for re-appointment. The MPC will meet at least four times a year and decisions at the meeting will be publicised.

The MPC will be entrusted with the task of fixing the benchmark policy rate (repo rate) required to contain inflation within the specified target level. But fixation of inflation target will be with due emphasis on the objective of growth and challenges of an increasingly complex economy.

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