India Keeps Inflation Target Unchanged For The Next Five Years

The Indian government has kept the inflation target for the next five years unchanged at 4 (+/-2)%, according to a notification dated March 31. The notification ends all speculation of a shift in favour of a higher inflation goal.

How Will Bond Markets React?

The reiteration of the inflation target will mean that the MPC will need to maintain a watchful eye on inflation.

After a brief drop to 4% in January, retail inflation rose once again in February to above 5%. Retail inflation remained above the RBI’s target of 4(+/-2)% for eight months in the current financial year. Should inflation pressures persist, the MPC may need to speed up its process of normalisation post the Covid-19 shock.

So far, the committee and RBI Governor Shaktikanta Das have assured that policy will remain accommodative into the next financial year. Explaining the MPC’s guidance in, Das said the commitment to keep an accommodative stance “during the current financial year and into the next financial year” is reflective of a time-based guidance; whereas on the other hand, the expression “to revive growth on a durable basis” characterises a state-based guidance; that is, guidance contingent on the state of the economy.

Despite that bond markets may worry about quicker normalisation of monetary policy, said Barua.

Rao, however, said that over the medium term, the continuation of the existing inflation target should be comforting for the bond markets. “Bond markets should positively react with a continuation of the same framework as it has helped in anchoring inflation expectations which should rein in negative sentiments. Higher inflation would have meant higher interest rates,” she said.

In Sync With RBI View

The view taken by the government is in line with that of the central bank.

Ahead of the review, the RBI’s research department has favoured retaining the inflation target. “The current numerical framework for price stability—an inflation target of 4% with a +/-2% tolerance band—is appropriate for the next five years,” the RBI said in its ‘Report On Currency And Finance’ released in March.

“Trend inflation to which actual inflation converges after a shock provides an appropriate benchmark for the inflation target,” the report said. “Trend inflation has fallen from above 9% before FIT to a range of 3.8–4.3% during FIT, indicating that 4% is the appropriate level of the inflation target for India.”