India Poised to Maintain RBI's 4% Inflation Target

India's strategy will include maintaining the Reserve Bank of India's (RBI) 4% headline-inflation target, located within a 2%-6% range, as this approach has been effective in establishing price stability, as per Bloomberg report. The target is renewed every five years and will be reviewed in March, and is expected to remain unchanged, according to sources within the finance ministry.

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Evolution of Inflation Targeting

The flexible inflation-targeting framework has incorporated an explicit price mandate for the RBI, which has been reinstated every five years and was extended as well. Input from stakeholders continues to provide support for the continuation of the framework. The benefits of the framework allow for greater stability of expectations in a time when there is greater pressure to grow the economy.

Track Record: Stability with Pandemic Volatility

For approximately three years of the last decade, inflation remained nearly constant. Despite rising volatility levels during the pandemic, inflation volatility has decreased significantly in the last few months, as evidenced by November's retail inflation rates being lower than October's historic lows, reflecting some degree of economic resilience.

Reasons to Retain Policy Rate Level

The 4% midpoint rate represents a balance between economic growth and price stability for India's fastest-growing large economy. Any reduction in the 4% level will likely constrain lending/capital investment growth; conversely, an increase would likely cause imported inflationary pressures resulting from the Rupee's pricing structure. Last month saw moderate inflation rates due to food supply chain resolutions and moderating food prices, supporting the rationale for maintaining the policy rate at 4%.

Global Comparisons

The Indian inflation band is similar to the developed markets' 2% band; however, this Indian band allows for broader flexibility with respect to emerging shocks. The two metrics of success are lower CPI volatility and more credible forward guidance. Retaining the status quo (4%) provides continued policy certainty for maintaining GDP growth above 7% and helps to dampen the potential for interest-rate volatility. The primary sources of risk to the economy come from elevated oil prices due to geopolitical events and failed Monsoon seasons. Conclusively, it is the determination of the Reserve Bank of India to have the tools necessary to mitigate these risks, including adjustments to the repository rate and liquidity operations.

From a market perspective, retaining the status quo will relieve expectations of a more hawkish monetary policy, which would support continued bond yields around 6.8% and preserve the value of the Indian Rupee. 

The Reserve Bank of India and the Fiscal Government are working together on coordinating fiscal-monetary policy, as demonstrated by the glide-path deficit reduction strategy. Ultimately, maintaining the status quo will promote financial deepening, particularly regarding interest-linked bonds