In his recent speech at Princeton University, USA, Reserve Bank of India (RBI) Governor Sanjay Malhotra explained the contours of policy-making and acknowledged that uncertainty is central to monetary policy. One of the key roles of RBI is to ensure price stability.
“It is a goal all central banks follow – not only because inflation is a regressive tax, which hits the poorest hardest, but also because price stability is important for businesses and households to plan and invest confidently. Unlike some countries like the USA, which have an explicit dual mandate and others like New Zealand, which have an explicit single mandate, we have price stability as the primary mandate to be pursued, keeping in mind the objective of growth,” Malhotra noted.
West Asia contributes about one-sixth of the country’s exports and one-fifth of imports, half of the country’s crude oil imports, two-fifths of fertilizers imports and almost two-fifths of inward remittances.
“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. 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,” Malhotra said.
In such uncertain times, it is important to be agile and nimble, maintaining a broad policy stance and avoid making firm commitments of the future path of policy. “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 a 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,” Malhotra said.
One of things which has worked well, according to him, is the inflation targeting under a Flexible Inflation Targeting (FIT) framework which was adopted in 2016. This has helped in navigating through persisting shocks from the pandemic to the Ukraine war. Under this mandate, the inflation target is set at 4 per cent, with 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,” Malhotra said.
Since the adoption of FIT, India’s average headline inflation has dropped to 4.7 per cent (September 2016 to December 2025), down from 7.4 per cent in the prior years (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. Inflation expectations are better anchored and less volatile. Post supply chain disruptions due to COVID and the Ukraine war, inflation in India converged to target faster than many advanced countries, he said.
The Reserve Bank of India kept its policy rates unchanged in its April meeting, amid uncertainty driven by the West Asia conflict. The central bank has chosen to keep its powder dry. It would be interesting to see what path it takes amid the emerging uncertainties, given RBI Governor’s hint on policy making.
