“I am reminded of what Alan Greenspan (Former US Fed Chairman) once said that uncertainty is not just an important feature of the monetary policy landscape; it is the defining characteristic,” he said speaking on the topic “RBI’s Role in India’s Growth and Navigating Global Challenges” at Princeton University, USA on 18 April.
“Since, uncertainty is central to monetary policy, the broader guiding principles of our policy-making do not change. It is only their application, which changes,” Malhotra said.
The first principle is to prioritise robustness over optimality. It involves risk management. We try to understand the risks arising out of the uncertainties, assess their probabilities, quantify their impact and then devise a policy that maximises best policy outcomes of price stability and growth, he said.
“If the central bank is unsure of the magnitude of the effect of a change in its instrument, it should change that instrument less than it would, were if it was sure. In other words, this is the policy of gradualism. There are, however, exceptions to this rule as in the case of inflation persistence,” Malhotra said.
“If central banks do not react under uncertainty or react gradually, it could be difficult to manage inflation expectations. Therefore, anchoring inflation expectations becomes crucial, which is another important objective that we pursue through various tools including providing forward guidance,” he added.
“Our fourth guiding principle is transparency, which provides predictability and credibility, and thereby enhances effectiveness. It also removes uncertainty from the minds of economic agents,” Malhotra said.
Lastly, clear communication of a central bank’s strategy and policy decisions, is a very potent underlay to achieve the objectives of monetary policy. It brings clarity of the approach and thus helps in both improving the transparency and anchoring inflation expectations, he said.
Malhotra also went to explain the impact on India from the West Asia crisis and how the RBI is tackling it.
“Coming to the present crisis, it particularly impacts us as West Asia contributes about one-sixth of our exports, one-fifth of our imports, half of our crude oil imports, two-fifths of our fertilisers imports and almost two-fifths of our inward remittances,” he noted.
“The appropriate monetary policy response to such a supply shock is to look through the first-round effect to the extent that it does not feed into second-round dynamics. Second-round effects are the real concern. They can materialise if the supply chain disruptions continue for long,” Malhotra said.
Then, what began as a supply shock can become embedded in the general price level. Preventing this entrenchment is where monetary policy has a primary role to play — through its influence on inflation expectations rather than through blunt demand compression, he pointed out.
” Moreover, in uncertain times such as this, it is important to be agile and nimble, maintaining a broad policy stance, and avoid making firm commitments of the future path of policy,” Malhotra said.
“In such circumstances, our broad approach has been to be even more data dependent and to continuously reassess the balance of risks. We are therefore in wait and watch mode now. Moreover, we have been maintaining a neutral stance for the last few policy cycles. It preserves the flexibility to respond as the inflation-growth dynamics evolve,” he said.
“Our decade-long experience with the Flexible Inflation Targeting (FIT) framework, in navigating through persisting shocks from the pandemic to the Ukraine war, suggests that it has served us well,” Malhotra said.
“We formally adopted this mandate in 2016. We have a Flexible Inflation Targeting (FIT) framework. It is flexible because, while we have a point target (4 per cent), there is a band of 2 per cent on either side. The relatively wide tolerance band around the target allows us to navigate the supply shocks – internal as well as external, given the large weight of food and fuel (supply side factors) in the Consumer Price Index basket,” he noted.
Since we adopted FIT, our average headline inflation has dropped to 4.7 per cent (September 2016 to December 2025), down from 7.4 per cent in the years’ prior (April 2012 to August 2016). Moreover, headline inflation volatility came down to 1.7 per cent from 2.4 per cent over the same period, Malhotra said.
“Inflation expectations are better anchored and less volatile,” he said.
Even in terms of global perspective, the FIT framework has been a success. From the highest average inflation among both advanced economies and Emerging market and developing economies (EMDEs) during 2006-2015, inflation in India has moderated to below the average of EMDEs during the last decade, Malhotra noted.
“It is also pertinent to mention that post supply chain disruptions due to COVID and the Ukraine war, inflation in India converged to target faster than many advanced countries,” he said.
“While we do give credit to monetary policy and flexible inflation targeting for the improvement in price stability, I may mention that fiscal policy has an equally important role to play in this regard. This is specially so in a country like ours, where supply side factors play a large role in inflation,” Malhotra said.
During the current crisis, domestic production of oil and gas is being ramped up. Sources of imports are being diversified. While there is no shortage of oil, given the reserves maintained by us, there is some rationing of gas for industrial purposes. The oil marketing companies and government have absorbed the price pressures in oil, while passing on some of the price pressures on gas to the consumers, he pointed out.
Moreover, fiscal consolidation has progressed steadily in recent years, with enhanced efficiency in tax collections and improvement in the quality of expenditure, Malhotra added.
“The resilience of the Indian economy is not by chance. It is because of the robust policy frameworks that have been successfully developed. It is due to the strong and credible institutions that have been assiduously built. It is on account of the various reforms undertaken steadily over the years. It rests on a foundation of stability and inclusion,” he said.
