Inflation targeting: RBI governor’s plan for India – By Dr. Bobby Srinivasan and Dr. Sudhakar Balachandran

Targeting simply means focusing and select objects to be dealt with. In our context, is the high inflation rate prevailing in India. The CSO recent data released by them indicates that WPI is around 6% while CPI is around 9%. These are intolerable levels and if persisted will continue to destroy the purchasing power of rupee. The inflationary expectation gets built in the common man’s decision making and so he rushes to hedge himself against this monster. As more and more people get involved trying to beat the inflation asset prices like land building, gold, etc move up more rapidly giving rise to higher rate of inflation. It may not be easily apparent but the prices of wheat affects the prices of rice, barley, oats etc and they all move in the same direction. In this case it is up. Given this present scenario the RBI governor wants to control the rate of inflation by targeting it to a specific level.

Dr. Rajan, the RBI governor wants to keep the inflation rate for 2015 at 8% and at 6% for 2016. Is it achievable? Can he do it and how does he plan to do it are all questions. First he believes that the economic tools that he has with him have the power of delivering it. For example he thinks that by increasing the repo rate or the CRR or adjusting the level of SLR he could get there. Other countries have achieved it. Paul Volcker the former Federal Reserve Chairman used the discount rate and the Fed funds rate to destroy the inflation that was hurting the US economy in the 1980’s. The process killed growth, increased the rate of unemployment and shook consumer’s confidence.

Unlike the US, a major part of our economy is unorganized. We have 1 bank branch for 12-13 thousand people. A major part of Indian villages do not have banks and all transactions use cash. Besides, the velocity of money is very high, since between the borrower and the lender there is no institution. This actually causes inflation rate to go up and the RBI has very little say in this matter. Yet another aspect of inflation is the traditionally built in supply chain which ensures the flow for example from the farm to the ultimate consumer through multiple intermediaries and stages. At each stage, a cost is added to reflect the interest cost, labor, storage, profit etc. When the product reaches the consumer, he will have paid for the services of many and he has no control over it.

Currently most of the global countries are fighting hard the bigger evil namely deflation. Japan is in the thick of it, euro zone countries have entered into it and even the US is steadily moving towards lower growth. There is no telling what will happen when the quantitative easing comes to a halt in the US. So Dr. Rajan may get some help from this trend but cannot count on it. All we can do is wish him to succeed as we are the ultimate beneficiary.


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