Why RBI cannot adopt inflation targeting?

RBI website has a superb interviewof RBI Governor Dr Subbarao. The interview was done by Central Banking Publications, London. He points to how he has used his experience of real economy to understand the impact of the crisis and make the necessary moves. He also wishes to make three changes:

RBI to acquire greater proficiency in managing monetary policy in a globalised context. India is going to become more and more integrated.

Second, we have to make the RBI more transparent. We need to improve communication at both technical and non technical levels.

Third, at a very personal level, I would like to de-mystify the office of the governor. What I mean by this is that I want our staff to understand that even governors do not know everything, that they have to make judgement calls in a context of uncertainty when the pros and cons of their actions are not completely clear.

His view on inflation targeting:

CB: Do you feel that the Reserve Bank of India’s relative scepticism towards inflation targeting has been vindicated by recent events?

DS: Yes, to a large extent. Because, in India, inflation is influenced by a number of factors besides excess demand in the context of easy liquidity. We’re an import-dependent economy that is reliant on importing commodities. So, import prices can drive up inflation. Capital flows could impact inflation. Decisions by other central banks could also cause inflation, especially in a globalising world. In a crisis such as this, inflation could also come through the trade channel. Also, India is largely an agricultural economy, even though agriculture now accounts for less than 20% of GDP. So, our agriculture prices are vulnerable to monsoon and adverse weather conditions, and beyond the pale of monetary policy action. Because of this, inflation targeting is neither possible nor advisable for the Reserve Bank.

Hmmm…All he is saying is India has many structural problems and RBI is the best placed institution to manage all. The critics say that leaves RBI with too much to do and focus on price stability is lost. However, the suggestions for who would manage the other tasks is never really discussed much.  RBI plays a much larger role in Indian economy than most can ever imagine and that has to be appreciated. It is not a plain inflation mandate for RBI and as Dr DS points- it cannot even have.

Slowly and gradually, Indian Govt is taking away functions from RBI like that of a I-Banker to Govt by setting up a NTMA. And as economy and other institutions mature, so would the rest of the functions. Till then, we need RBI in the current form.


This interview and subsequent post set me thinking- how have other developing economies that have adopted inflation targeting managed the transition (see this handbook for a complete list of ITF central banks)? Was it just about giving central banks an ITF? Who managed other tasks for other developing economies like South Africa, Ghana  etc which also should be having the same kinds of problems – high poverty, agri based etc. If it were the central banks how did they pass on the responsibility to others?

Somewhere down the line I think the developing countries that managed to have ITFs, the central banks before ITF were responsible mainly for monetary policy. Mon pol in these was not designed/focused properly and an ITF precisely allowed the same. With India this is not the case as RBI has always had multiple functions and is gradually giving up its tasks to other institutions being set up by the govt.

The same story  actually applies for developed econs where numerous speeches/research etc points that their central bank was looking for a price stability anchor as both exchange rate and monetary targets did not prove effective. However, for developing economies we don’t have such an enriching literature. The research usually is on the performance of inflation when ITF was adopted etc which is not useful for central banks like RBI. We need to know/understand better how and whether the central banks had other tasks as well. If they had, who manages them now?

2 Responses to “Why RBI cannot adopt inflation targeting?”

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