Why govt needs to pitch in for inflation targeting

Inflation has halved in the past two years, but apprehension that it may rise again has led the government and the Reserve Bank of India (RBI) to adopt inflation targeting.

Inflation control is the RBI's central responsibility, but that does not absolve the government of its role in taking steps to correct the imbalance between food consumption and food production, which is the main source of inflation in the country.

For now, the government will tolerate 6 per cent inflation. But from next year onwards, inflation will have to be within a range of 4 per cent, plus or minus 2 per cent.

Inflation is a highly sensitive political issue and it is no wonder that Finance Minister Arun Jaitley was eager to minimise the government's role in the framework agreement signed with the RBI.

Food inflation has been the primary source of inflation measured either by WPI (wholesale price index) or CPI (consumer price index), and RBI's monetary policy has little control over it because food is not purchased by the consumer from borrowed money. It is precisely for this reason that the doubling of repo rate in the past did not slow down inflation. That goes for crude oil as well, whose prices are decided internationally depending on overall demand and supply conditions. No change in interest rate by the RBI can impact oil prices.

But an increase in interest rate is necessary to prevent real interest rate from turning negative. This is why the country witnessed the strange combination of high inflation and low growth, which made monetary policy ineffective.

The central bank's policy can work only with the combination of high inflation and high growth or low inflation with low growth, which makes the government's role crucial. The centre needs to give greater attention to balanced food production and food consumption.

(The author undertakes research on current macroeconomic issues of interest, mainly to industry, as president of RPG Foundation, a private think tank. Any opinions expressed here are the author's own.) - Reuters