India should rethink basis of inflation target

New Delhi

ANY day now, India's government is set to announce an official inflation target for the first time - a major step in the modernisation of its economic institutions, particularly the central bank. The idea has been proposed and debated for years, including in a much-discussed 2008 report written for a previous Indian administration by Raghuram Rajan, now governor of the Reserve Bank of India (RBI). Mr Rajan's proposals have now been formalised, after much back-and-forth between the RBI and the government, in a formal monetary policy framework that includes a mandate for the RBI to target a specific inflation rate.

The arguments in favour of an official target are persuasive. The goal provides a degree of transparency to central bank actions, which helps investors. It ensures that the central bank has greater independence - particularly important in a country such as India, where governments have been known to pressure the RBI to ignore fiscal profligacy and keep monetary policy loose. Most importantly, by creating an institutional structure, it lends the RBI a credibility that isn't dependent on whoever happens to be governor.