Inflation has been maintained at below 4% since 2016 when the target rate was declared
One noteworthy feature in the recently concluded general election, unlike in previous elections, was the absence of a debate on inflation. On the contrary, the issues raised were of a fall in prices of agriculture commodities, farmers’ distress and unemployment, etc.
Inflation implies an erosion in purchasing power per unit of currency. In other words, each rupee can buy fewer goods and services than it could do before. Fixed income persons like salaried persons, pensioners, etc., suffer. However, to some extent, salaried persons at higher levels in the government/public sector sometimes gain as they are compensated by the hike in dearness allowance (DA) linked to inflation. But for the common man certainly, higher inflation is a tax on his fixed income as it reduces his purchasing power. It must be the endeavor of any government to keep inflation at a moderate level.
Pursuant to the amendment to the RBI Act on May 2016, the amended preamble stipulates having a modern monetary policy framework to meet the challenges of an increasingly complex economy. The primary objective of the monetary policy is to maintain price stability while keeping in mind the objective of economic growth.
In August 2016, the government, in consultation with RBI, notified 4% Consumer Price Index (CPI) inflation as the target till March 2021, with a tolerance limit of 6% on the upper side and 2% on the lower side. And, non-achievement of these targets for three consecutive quarters will be treated as a failure. Prior to this notification, the flexible inflation targeting framework was governed by an agreement between the government and the RBI.
Consumer Price Indices (CPI) measure changes in retail prices of selected goods and services that households buy for consumption and it reflects the changes in the purchasing power of their income and welfare. The year-on-year CPI is recognized as a measure of inflation. The government publishes CPI on a monthly basis, with 2012 as the base year (CPI-2012=100).
From September 2016 to May 2019, the simple average CPI inflation was 3.55%. The lowest CPI inflation was registered in June 2017 at 1.46% and, more recently 1.97% in January 2019. The maximum was in the month of December 2017 at 5.21%.
After the introduction of inflation targeting, inflation has never exceeded the 6% ceiling. However, till May 2019, on two occasions, the inflation was below the lower limit of 2%. Fall in inflation is certainly good for the common man. However, inflation went up to 3.05% in May 2019 (provisional) as against 2.99% in the previous month.
This is against the backdrop of an average increase of 5.73% from the introduction of a new series of CPI (with the base year 2012) to August 2016 (that is, till inflation targeting was fixed). During the initial period of introduction of the new series, inflation was more than 8%.
Whatever may the criticism on shifting the base year of CPI to 2012, one has to appreciate the government/RBI for keeping inflation well within the target.
Lowering repo rates
The RBI’s Monetary Policy Committee determines the policy interest rates required to achieve the inflation target.
RBI uses various direct and indirect instruments to implement monetary policy, including Repo Rate, Reverse Repo Rate, Liquidity Adjustment Facility (LAF), Marginal Standing Facility (MSF), Corridor, Bank Rate, Cash Reserve Ratio (CRR), Statutory Liquidity Ratio (SLR), Open Market Operations (OMOs) and Market Stabilisation Scheme (MSS). Repo rate is the most important policy rate as it signals the policy stance to the government and the entire economy, especially banks.
The RBI is confident that a demand-led price surge is unlikely and so inflation is under control. On June 6, during the bi-monthly monetary policy, the repo rate was reduced by 25 basis points (from 6% to 5.75%). It is expected to spur economic growth as lending rates by banks and other financial institutions are expected to come down.
The present repo rate of 5.75%, down from 6.5% in December 2018, is the lowest in a decade. The reduction in the repo rate will have a corresponding reduction in other policy rates. The money supply is kept under control.
A lower level of inflation means prices are still going up but at a lesser pace. Moderate inflation is positive to economic growth. Savers benefit when inflation is low as their real interest rate goes up.
Today, even when banks pay around 7-7.5% interest on long-term fixed deposits, the real return amounts to more than 4% (interest rate minus inflation). Compare this scenario when the interest rates were 8-8.5% and inflation was around 8%. The real return was negligible or even nil/negative.
One has to complement the government and RBI not only for declaring inflation targeting and strictly adhering to the commitment till now and thus not adding to the common man’s misery. Let us hope the positive trend continues.
This article was originally published in the Deccan Herald