MPC meeting today and history of Inflation targeting

In normal days when we do the global market update, it starts with the US then comes to China and then covers the Euro. The equities, bonds and currency movements also get their fair share of coverage. The sequence in a sense reflects the reality of our times, underlining the point that all the economies are coupled with global movements owing to globalization and free flow of capital. The Indian economy is no different, and many a times the movements in the Indian markets are decided globally with domestic events presenting themselves as of little consequence. But not today.

Today is the day of the RBI’s MPC meeting where they will decide about the rate trajectory of the economy. Market expectations are divided between a 25 bps cut and a pause. Some unconventional measures can also not be ruled out. The RBI has so far tried many tricks to support growth in these troubled times - the last monetary policy was even pre-poned to deliver a cut. Measures like TLTRO and operation twists were also announced. The basic idea was to support the growth by keeping the borrowing costs for the businesses down.

However the mandate of the committee is inflation targeting to keep the CPI in the band of 2-6%. In case the committee fails to control the inflation on either side for 3 quarters it has to answer the government. Going solely by the rule book, the possibility of a rate cut remains slim as the last CPI reading released in July was 6.09.

Now this brings us to the fundamental issue that whether the current scenario beset by the pandemic is an exceptional one where the rules made during normal times should not apply. This requires us to enquire why the system was put in place in the first place. Raghuram Rajan in his book I do what I do which is actually a compendium of his speeches, writes at length about why inflation targeting is important, his primary argument being that any action by the central bank should be deeply steeped in rules and adopting an inflation targeting mandate gives the markets and businesses a clear anchor to base their decisions. The twin targeting of growth and  inflation at the same time, which sometimes run in opposite directions, results in a muddled approach and lead to withering institutional accountability too.

The decision will be announced at 12:00 noon IST. The 10 year bond (5.79% 2030)trades at 5.8150 currently.