Mumbai: Reserve Bank Governor Raghuram Rajan has said the target band for retail inflation could tighten much further in the future as the central bank becomes more comfortable with it.
"Going forward, we will seek to bring inflation to the mid-point of the band of 4+/-2 per cent provided for in the monetary policy framework agreement, i.E., to 4 percent by the end of a two-year period starting FY17," Rajan had told analysts on Wednesday after he surprised the markets with a 25 bps policy rate cut citing supporting data prints.
Answering a question from an analyst, Rajan had explained further, "Given that this is a process (the recently signed monetary policy framework agreement between the Reserve Bank and the government) that is just starting, we have somewhat wide bands around it.
"My belief is, as we get more comfortable, and I am talking in the five-to-ten year scenario, these bands could tighten. But for now, we think these are appropriate (at 4 per cent by FY17)," Rajan had said.
Explaining the view further, he said, "The way we think about this 4 percent mid-point is that if we really look at the industrial countries they are seeking, for the most part, a 2 percent nominal interest rates and if we say on top of that we have a 2 percent productivity advantages as we catch up in growth then a 4 percent inflation rate on our side will tend to keep our nominal exchange rate at pretty much a level vis-a-vis industrial countries.
"So, that is really the thinking behind why 4 percent. It is also that previous committees have gone into this in great detail and they have suggested that 4 percent may be comfortable for us to try and reach. But, also, given that this is a process that is starting, we have somewhat wide bands around it," Rajan had said.
On the real rates, he said, "As far as the level of real rates goes, I have said repeatedly that, at this point in the cycle, 1.5-2 percent real is probably appropriate."
Under the monetary policy framework agreement signed by the RBI and the government on February 20 to set up a monetary policy committee that will give an inflation targeting to the RBI, the central bank has to keep the retail inflation in a 2-6 per cent band starting from April 2016, which means that CPI inflation target stands at 4 per cent.
The RBI has glide path of 6 per cent for 2015 and 5 per cent for January 2016. Inflation for January stood at 5.11 per cent and analysts are expecting it to hover around 5.5 per cent in February.
Rajan had said RBI will seek to bring the inflation rate to 4 per cent by the end of a two-year period starting 2016- 17.
When probed how much support the RBI needs from the government to achieve this target, Rajan said the comfort should be taken from the government's willingness to move to an inflation targeting model.
"That is our framework, and the government has to be supportive in this process. And it has been in the past," Rajan had said.
