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Impact of inflation targeting in India

Synopsis: According to the Executive Director IMF, Surjit S Bhalla, Inflation targeting has been ineffective in controlling inflation. Moreover, it has also contributed to a decline in GDP growth because of high repo rates.

About inflation targeting

  • The concept of ‘Inflation targeting’ was got acceptance in New Zealand first. Later, 33 countries adopted it as well.
  • India formally adopted it in 2016, at the first meeting of the RBI Monetary Policy Committee (MPC).
  • The MPC considered a real repo rate of 1.25 percent as the neutral real policy rate for the Indian economy.
    • A neutral policy rate means the policy rate will be consistent with the growth potential of India.
  • The primary goal of inflation targeting is to contain inflation at around 4 percent, within the allowable range of 2 to 6 percent.

What are the impacts of inflation targeting in India?

The author, in his research paper, has evaluated the inflation target in a global context. It made the following conclusion based on the last 40 years for both the inflation targeting economies and the non-targeting economies.

average median inflation

  • First, countries that did not adopt inflation targeting were able to control inflation better than the countries that used inflation. For example, India’s inflation was around 5.2% (2015-19) for the same period it was 2.4% for economies that did not adopt inflation rate targeting.
  • Second, inflation depends on global variables, and it is not dependent upon one single factor. So, using an inflation targeting mechanism will not effectively control inflation. For example, 2000-04, has been the golden period of inflation all over the world even in India. During this time, inflation rate targeting was not in place in India, yet inflation was very low.
  • Third, the belief that a high Fiscal deficit will contribute to high inflation is not true. For example, FRMB act was in place after 2003. However, Inflation in India increased from 3.9% (2000-04) to 7.1% (2005-09) despite the fiscal deficit were limited as per the FRBM act.
  • Fourth, inflation targeting has negatively impacted GDP growth. High policy rates (repo) maintained to control inflation affected the cost of domestic capital. It led to a decline in investment rate thereby resulted in less GDP. For example,since2016, (after inflation rate targeting was institutionalised), there has been a steady increase in repo rates, and a steady decline in GDP growth

Source: Indian Express

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