RBI report: Inflation target between 2 to 6% for next 5 years
On Friday, the Reserve Bank of India said that the inflation target of 4 percent is appropriate for the next five years to maintain stability.
“Threshold inflation above which growth is unambiguously impaired ranges between 5 and 6 per cent in India, indicating that an inflation rate of 6 per cent is the appropriate upper tolerance limit for the inflation target,” the RBI said in a report on Currency and Finance (RCF) for the year 2020-21.
The statement made by RBI is based on the decline in inflation since 2014. The observation of 4 % comes as the upper tolerance level is 6% and lower tolerance level is 2%.
“Hence, the current numerical framework for defining price stability, that is an inflation target of 4 per cent with a plus/minus 2 per cent tolerance band is appropriate for the next five years,” the report said.
“On the other hand, a lower bound above 2 per cent can lead to actual inflation frequently dipping below the tolerance band while a lower bound below 2 per cent will hamper growth, indicating that an inflation rate of 2 per cent is the appropriate lower tolerance bound.” the report said.
The 4% target was fixed by the Central government along with RBI under section 45ZA of the RBI Act 1934 between August 5, 2016 and March 31, 2021.
“Trend inflation to which actual inflation converges after a shock provides an appropriate benchmark for the inflation target; trend inflation has fallen from above 9 per cent before FIT to a range of 3.8 to 4.3 per cent during FIT, indicating that 4 per cent is the appropriate level of the inflation target for India,” the report emphasised.
“On the upper tolerance limit, international experience suggests that countries with a large share of food in the CPI basket tend to have higher inflation targets and wider tolerance bands. Threshold estimates over a longer sample period work out to 6 per cent, beyond which tolerance of inflation can be harmful to growth”, the report said.
“Hence, the current tolerance band of plus/minus 2 per cent may be retained, notwithstanding the central tendency emerging from the country experience of lowering targets and narrowing bands over time,” said the report.