New Delhi - Indian Prime Minister Narendra Modi’s government formally agreed on an inflation target with the central bank that mirrors the goal Governor Raghuram Rajan had sought last year.
Under the agreement, announced in Saturday’s budget and released in full today on the ministry’s website, the inflation target for the financial year through March 2017 “and all subsequent years” shall be 4 percent, plus or minus 2 percent. The figure is the same as what a central bank panel recommended.
“The objective of monetary policy is to primarily maintain price stability while keeping in mind the objective of growth,” the agreement says.
The formalisation of the target, the biggest revamp of the central bank’s mandate in its 79-year history, reduces the risk that future policy makers will abandon the overhaul in a nation that last year saw Asia’s highest inflation rate. Rajan had informally adopted an inflation target after taking over the central bank in September 2013.
“There was a lot of speculation whether the RBI has been pressured by the government to lower interest rates,” said Madan Sabnavis, chief economist at CARE Ratings in Mumbai. “I think that kind of speculation has been put to rest.”
The central bank governor will determine the policy rate and other measures, with the deputy governor doing so in his absence, the agreement says. The central bank will be seen as failing to meet the target if consumer-price inflation isn’t within the band for three consecutive quarters, it says.
RBI Act
Finance Minister Arun Jaitley said on Saturday that he’d amend the RBI Act to create a monetary policy committee, without providing a timeline. The framework agreement didn’t mention the committee.
The agreement also says the central bank will seek to bring inflation below 6 percent by January 2016, a target Rajan has previously mentioned. The monetary authority will “set out in a report” any reasons for failing to meet the target and also include proposed remedial measures and a timeline in which it will achieve success.
Rajan held the benchmark interest rate at 7.75 percent last month following an unscheduled quarter-point reduction in January. He said he was looking for “high-quality fiscal consolidation” in addition to softer inflation before further reducing the rate.
‘Playing ball’
Interest-rate swaps show investors expect about 75 basis points of rate cuts in India by the end of 2015, the steepest decrease after Turkey among 14 emerging markets tracked by HSBC Holdings PLC.
“The government has done a lot of things the RBI has asked for,” said Edward Teather, senior economist for UBS Group AG in Singapore. “They’re playing ball with the RBI - that will help in the broader context of getting Rajan to cut rates.”
India’s monetary authority isn’t formally independent. The Reserve Bank of India Act 1934 says the governor will be appointed by the prime minister and allows the federal government to direct the central bank on what it considers the public interest.
* With assistance from Kartikay Mehrotra in New Delhi
Bloomberg