Former RBI governor Subbarao questions inflation-targeting, doubts its efficacy

The former governor D Subbarao in his memoir doubted the efficacy of inflation targeting citing lack of global experience.

By: PTI | Mumbai | Published: July 27, 2016 6:37 pm
subbarao, raghuram rajan, inflation targeting, monetary policy, inflation target 4%, rbi governor rajan, rbi inflation target, modi, pm modi, narendra modi, arun jaitley, india news “Inflation has come down to such a low level now.. even gone below 5 per cent, but now it is inching back. So achieving 4 per cent inflation target by January 2018 is going to be quite challenging,” Subbarao said.

Former Reserve Bank governor Duvvuri Subbarao has doubted achieving the 4 per cent inflation target set under the new MPC set-up given the narrow margin the new price index has now and the way prices have been moving up in recent months.

“Inflation has come down to such a low level now.. even gone below 5 per cent, but now it is inching back. So achieving 4 per cent inflation target by January 2018 is going to be quite challenging,” Subbarao told PTI.

Explaining his position, the former governor who in his memoir doubted the efficacy of inflation targeting citing lack of global experience, said “at the margin, the challenge of reducing inflation from the current 5.8 per cent to 4 per cent is going to be much more difficult than bringing it down from 8 per cent to 5.8-5.5 per cent.”

The wholesale inflation accelerated for the third straight month in June hitting 1.62 per cent on costlier food and manufactured items, after remaining in the negative territory for close to two years on poor demand and under utilisation of industrial capacity coupled with the crash of commodity prices, especially that of crude oil and metals.

The hardening of the WPI index follows an uptick in the more flippant consumer price inflation, which hit a 22-month high of 5.77 per cent in June.

In the June policy review, RBI Governor Raghuram Rajan had left the interest rates unchanged, citing rising inflationary pressure, but hinted at a reduction later this year if good Monsoon helps ease inflation.

Inflation-targeting was mooted by the Percy Mistry committee report and fine-tuned by the Raghuram Rajan report.

Inflation-targeting, unveiled in January 2014, could be counted as a key legacy of outgoing Governor Rajan, who chose CPI over WPI for policy setting.

Subbarao, who was the governor for a five-year period from September 2008 to 2013 and now teaches at the National University of Singapore, said inflation is driven by oil and food prices, which are vulnerable to supply shocks and are not easily controlled through monetary policy.

In his just published book of his RBI tenure ‘Who moved my interest rate’ Subbarao is more vocal about having an inflation target.

“The world over, there is a rethink on its advisability. Global experience shows that an inflation-targeting framework is neither necessary nor sufficient to maintain price stability.”

Subbarao also pointed out the US Fed had in 2011 adopted a numerical target for its inflation objective, even as it is firmly committed to fulfilling its statutory mandate from the Congress of promoting maximum employment, stable prices and moderate long-term interest rates’.

“For sure, openly committing to an inflation target helps a central bank guide expectations, and thereby maintain stability in the economy.

“But that very stability can be impaired by a single-minded pursuit of the inflation target to the exclusion of other macroeconomic concerns,” he argues and advises that it makes sense to wait for the lessons to become clearer and then adapt them to our situation.”

Stating that our economy has some very unique peculiarities such as high fiscal deficits, administered interest rates on small savings, illiquid bond markets and poor monetary policy transmission among others, he fears inflation targeting under which Parliament sets a target for price index may become hostage to fiscal dominance.

“In an economy where short-term inflation is driven more by supply shocks, be they of food or energy, than by demand side pressures, can the Reserve Bank deliver on an inflation target? Will the government support the RBI by remaining committed to fiscal responsibility or will inflation-targeting become hostage to fiscal dominance?” Subbarao writes.

Considering these issues, he says it is better that the RBI does not get fixated on inflation targeting as it may be forced to take drastic measures to attain the target which may lead to lower growth hitting jobs.

“My main concern is that inflation-targeting in the face of these compulsions might lock the Reserve Bank into a no-win situation. If it is fixated on fulfilling its inflation target, there may be occasions when the Reserve Bank may have to tighten the interest rate so much that growth and jobs will be hit.

“On the other hand, if it fails repeatedly to meet the target, it will risk losing credibility. Once people have lost confidence in an inflation target, it becomes very hard for the central bank to persuade them to trust the target again,” he adds.

Subbarao, however, notes that the inflation-targeting framework is significant flexible as the the monetary policy framework agreement acknowledges that the objective of the monetary policy is to maintain price stability ‘while keeping in mind the objectives of growth’, thus discouraging the RBI from adopting a rigid approach to achieving inflation target.

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