The monetary policy committee headed by the RBI Governor is set to revise the policy framework and inflation targets by March 31 - the first review since it was tasked with a mandated inflation target of 4 per cent with a 2 per cent deviation either way in June 2016, when it adopted a flexible inflation targeting model.
The RBI can pat itself for nearly achieving the inflation targeting goal with the consumer price index averaging 3.9 per cent during October 2016-March 2020, as it races to review the monetary policy framework for the first time in five years, according to a report.
The monetary policy committee headed by the RBI Governor is set to revise the policy framework and inflation targets by March 31 – the first review since it was tasked with a mandated inflation target of 4 per cent with a 2 per cent deviation either way in June 2016, when it adopted a flexible inflation targeting model.
Not only did the headline CPI inflation averaged closer to the target at 3.9 per cent during this period, inflation volatility, measured by its standard deviation, also declined to 1.4 during October 2016-March 2020 from 2.4 in 2012-16, BofA Securities said quoting the Reserve Bank of India data.
Indranil Sen Gupta and Aastha Gudwani, the house economists at Bank of America Securities India, in a note on Friday said they expect CPI inflation to average at 4.6 per cent in FY22, down from 6.2 per cent in FY21 and to stay within the RBI’s current mandate of 2-6 per cent.
For February, they expect the CPI print inching up to 4.8 per cent from 4.1 per cent in January on an unfavourable base and rising food and fuel inflation.
On the new inflation target, they expect the revised framework should continue with a band at 2 per cent on the lower end and 6 per cent at the upper end, and not a point target for CPI inflation as beyond 6 per cent as financial stability and growth may get impacted.
The February CPI is the last CPI inflation print before the RBI announces its revised monetary policy framework, reviewing its 4 +/-2 per cent inflation band by the end of the month.
Barring sporadic food-led inflation spikes, inflation trajectory is headed lower in FY22 and to average at 4.6 per as fundamental factors of inflation remain weak, because retail WPI at 2 per cent and core WPI at 3.7 per cent in January highlight that the fundamental factors of inflation are weak, they said.
The economists also expect the RBI to keep the operative inflation limit in their revised framework at 6 per cent combined CPI inflation as suggested in the recent currency and finance report.
The BofA Securities report blames the spike in inflation to the recent firming up of food prices, cooking gas and rising petrol prices. Despite this, inflation is still expected to stay within the RBI’s 2-6 per cent mandate in H1 of 2021.
Interestingly, at 45.9 per cent, the share/weighting of food in the total CPI basket in the country is the highest in the world.
The higher share of food in the CPI basket makes it prone to supply shocks. Thus a band is more apt than a point inflation target.
“As the concept of threshold inflation applies to the long run and growth is unambiguously impaired when inflation crosses 6 per cent, it is recommended that 6 per cent be maintained as the appropriate upper tolerance limit for inflation target to remain credible,” the RBI report on currency and finance said.
Globally, the output starts contracting after three-quarters of monetary policy tightening and reaches its trough in the fourth quarter before gradually returning to its baseline, and inflation begins to respond after seven quarters of the shock and the maximum impact is felt after 10 quarters.
When CPI data are used, the transmission of a policy rate increase to headline CPI inflation peaks after four years.