A few weeks after India’s Chief Economic Adviser Sanjeev Sanyal suggested that the government be inclined to stick to India’s inflation target when it comes to review next month, the country’s Chief Economic Adviser (CEA) KV Subramanian has called for a resumption of the old debate on the issue. Unlike Sanyal, who said that our 2-6% inflation band had worked towards an average target of 4% and that there was no need for revision, his top adviser in the finance ministry argued that it needed refinement. On Monday, Subramanian argued that while the Reserve Bank of India’s (RBI) monetary instruments are mainly addressing demand-side factors, Indian inflation is mainly dependent on supply-side variables for food prices. The policy of hard money is not very effective against the edible ones of prices with actual scarcity. In his view, it would be better to pursue major inflation, which excludes volatile commodities such as food and fuel. The CEA’s controversy is not new. His ‘core’ proposal is also missing. In fact, they were aired before the RBI officially adopted its inflation-targeted framework in 2016, mostly with analysts applying the price charts and some appeal. However, we must maintain the status quo.
While it is true that supply constraints play a huge role in the price dynamics of many commodities, it is all the same. And it does not justify change. To see why, focus on the bigger picture instead. The key variable that requires stability is the actual value of the rupee. This is total inflation — money chasing very few products. The money supply is very important. In fact, the monetary hypothesis that inflation has always been a monetary phenomenon everywhere has been well examined in India so far. After a double-digit spell a decade ago, inflation has largely tamed since the RBI targeted its instruments. Their effectiveness against the kind of economic dominance that India has recently reclaimed has not yet been tested, but the RBI should be given a chance to prove its capability on this front in the new circumstances. In particular, its Governor Shaktikanta Das expressed confidence in the current system and suggested maintaining the current target. If it works well, eventually India will have a reliable handle on price levels, which will be a significant benefit to the country.
However, this is an inevitable time for any policy adjustment that will allow the RBI to reduce general price stability. At this stage this goal is very important and now both the economic and monetary policy in India have been relaxed to help the economic revival. There will be more cash to turn around. In addition, there is inflationary pressure of capital inflows from abroad. Since our economy was weak before the uprising, some reflection must help. But tolerating inflation is a risky game of allowing real interest rates to remain negative for too long. It warps incentives in our market for credit and causes misappropriation of resources. All in all, the Dopish turnaround taken by the RBI in 2021-22 will keep prices in check. On one level, it is in favor of a debt-ridden government, which is tempted to shirk its burden, but at what cost? The rupee buys even lower and we have ruined the hard-earned profits of the last half decade or so. For the sake of macroeconomic stability, we must not loosen controls. As Harendra Kumar Behera and Michael Patra of the RBI argued in a recent working paper, “If it does not break, do not fix it.”