RBI agrees to cut inflation to pre-decided levels to tame prices

In a historic change in the monetary policy, the Reserve Bank of India (RBI) has in an agreement with the government committed to cut inflation to pre-decided levels to tame prices.

The Monetary Policy Framework Agreement, signed on February 20, binds the RBI to use monetary policy tools, including fixation of interest rates, to bring down consumer inflation to less than six per cent by January 2016 and to around four per cent by March next year with a band of plus or minus two percentage points by March 2017.

Chief economic advisor Arvind Subramanian told reporters in the national capital on Monday, "Decisions on whether to cut (interest rate) or not should be taken based on inflationary pressures ..."

While the agreement gives a free hand to RBI governor Raghuram Rajan to decide on monetary policy measures to achieve the inflation target, it also requires the Central bank to give out to the government a report in case inflation is more than six per cent or less than two per cent for three consecutive quarters. To give effect to the agreement, the RBI Act will be amended in the next fiscal.

If it fails to meet it, the RBI in a report to the government would give out the reasons for its failure, remedial actions proposed to be taken and an estimated time period within which the given target would be achieved.

In case of any dispute arising out of interpretation of the agreement, it would be resolved through a meeting between the RBI governor and the Government.

Asked whether it is the sole responsibility of the RBI to control inflation, finance secretary Rajiv Mehrishi said, "It is not a pass or fail test. It is just that you have to explain why you have been unable to do it."

The concept of inflation targeting in India was first suggested by a panel headed by RBI deputy governor Urjit Patel in January.

The panel had recommended transforming RBI to US Federal Reserve type body with the main objective of capping retail inflation at four per cent with a band of (+/-) two per cent.

The RBI is also required to make public every six months a document explaining the sources of inflation and the inflation forecast for the period between six to eight months.