India’s threshold inflation level is 6 per cent: Fromer MPC member

” Threshold inflation for India at around 6 per cent” say a research paper by former Monetary Policy Committee member Ravindra H. Dholakia and a team of economists Jai Chander, Ipsita Padhi and Bhanu Pratap. ” An inflation target that is lower than the threshold level, cannot achieve its potential output growth and the system would remain in long-run disequilibrium requiring constant policy interventions to stabilize” the study concludes.

The research paper is significant as the Reserve Bank adopted flexible inflation targeting framework as a formal monetary policy objective since 2016, under which price stability is the prime goal of monetary policy and the government sets an inflation target for the central bank. The current target is set at 4 per cent which can range in a band of 2 per cent either ways, which was set in April when the new MPC term started. The inflation targeting framework came for criticism from various quarters as CPI inflation crossed 6 per cent , beyond the upper end of the band for several months in FY’21 due to the restrictions caused by the pandemic induced nation-wide lockdown

But the findings of the study also show that the threshold inflation and corresponding growth depends on the other two parameters – the ratio of fiscal deficit to GDP and Current account deficit to GDP.

The concept of threshold inflation is linked to the level of inflation beyond which it becomes detrimental to economic growth.

The study has made estimates of the trade-off between long run inflation and steady state growth rate. A 100 bps ( one bps is 0.01 per cent) reduction in inflation from the threshold level could result in 40 bps loss in growth and 15bps of gain in the growth for 100bps reduction in inflation towards the threshold level.

Policymakers may choose to set the inflation target below the threshold level only after considering the costs of sacrificing growth and implied poverty alleviation rate with likely benefits in terms of the distributional and financial stability implications which are not examined in this study, the paper said.