RBI Alone Cannot Contain India’s Inflation, C Rangarajan Says In New Paper

The Reserve Bank of India cannot alone contain inflation as supply-side shocks need to be managed by the government, a former governor of the central bank has said.

In a paper titled The New Monetary Policy Framework—What it Means, C Rangarajan talked about the limitations of RBI's monetary policy in containing inflation.

"The inflation mandate, as already mentioned, must provide for a range and a time frame for adjustment which should not be too short. Nevertheless, monetary policy must act irrespective of what triggered inflation. Obviously, supply-side management is needed in situations of supply stock and that should be the responsibility of the government," he said.

According to the former RBI governor, the adoption of inflation targeting by India's monetary policy committee has given rise to many doubts and concerns. The new monetary policy framework requires RBI to maintain consumer price inflation at 4 percent with a margin of +2 or –2 percentage points.

"Thus in a sense, it is flexible targeting. The amendment to RBI Act also provides for the setting of a Monetary Policy Committee which will determine the policy interest rate in order to abide by the inflation mandates," he said.

The focus on inflation-targeting by monetary authorities hardly mean a neglect of other objectives such as growth and financial stability, he noted.

"Does the focus on inflation targeting by monetary authorities mean a neglect of other objectives such as growth and financial stability? Hardly so.

"What inflation targeting demands is that when inflation goes beyond the comfort zone, the exclusive concern of monetary policy must be to bring it back to the target level. When inflation is within the comfort zone, authorities can look to other objectives," the former RBI governor said.

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The monetary policy framework adopted by India and many other countries is correctly described as "flexible inflation targeting".

"This flexibility is extremely important because it emphasizes the uncertainties against which central bank have to operate," Rangarajan noted.

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The government had in 2016 constituted monetary policy committee to set the benchmark interest rate. The MPC is headed by the RBI governor. Of the six members, three are nominated by the government while the remaining are from RBI—including the governor. The committee takes decisions based on majority vote. Each member has one vote but the RBI governor has a casting vote in case of a tie.