Inflation targeting a 'credit positive' for India, says Moody's Investors Service

In a major boost to India's sovereign outlook, Moody's Investors Service said on Wednesday that the new 'inflation targeting' mechanism was a credit positive move and it would make Reserva Bank of India's (RBI) monetary policy tools much more effective.

Under the new 'inflation targeting' mechanism or the Monetary Policy Framework agreement between the RBI and the government, the central bank will target to lower inflation to below 6 per cent by January 2016 and further to 4 per cent with a band of (+/_-) 2 per cent in 2016-17. The RBI will have to explain the reasons if such targets are not achieved.

The credit rating agency said that the new mechanism would increase the predictability and effectiveness of the RBI's monetary policy, while the effectiveness of its monetary tools would increase because 'inflation targeting' would take into account future - rather than past - price trends.

"Quantitative inflation targeting will foster transparency and predictability in monetary policy, as capital market participants, businesses and the public understand the drivers of central bank actions," Moody's Investors Service Associate Analyst Shirin Mohammadi said, adding that the move was credit positive for the country.

"All of this will anchor inflationary expectations and increase the effectiveness of monetary policy tools in achieving their desired results," Mohammadi said, adding it would increase effectiveness of monetary policy.

Additionally, an increase in monetary policy transparency and effectiveness would lessen volatility in international capital flows into India and support institutional strengthening via accountability, Moody's added.

Unchecked inflation would have a greater chance of hurting growth, the rating agency cautioned, adding that between 2011 and 2014 inflation was largely driven by food and commodity prices but it ultimately compromised growth.

As the RBI implements its mandate to curb inflation regardless of its source, the government may heighten efforts to lower food inflation by reducing inefficiencies in food production, distribution and administered pricing, Moody's added.