Inflation Targeting in India - Issues and Prospects

This paper evaluates the case for inflation targeting (IT) in India. It states the objectives of monetary policy in India and argues that, with widespread poverty still present, inflation control cannot be an exclusive concern of monetary policy. The rationale for IT is spelt out and found to be incomplete. The paper provides some evidence on the effects of IT in developed and transition economies and argues that although IT may have been responsible for maintaining a low inflation regime, it has not brought down the inflation rate itself substantially and or changed the volatility of the exchange rate. Output movements in transition countries adopting IT have been higher than in developed market economies. I discuss India's experience with using nominal targets for monetary policy and why India is not ready for IT. Further, even if India's central bank wanted to, it could not pursue IT because the short-term interest rate does not have a significant effect on inflation. The paper concludes by listing monetary policy options for India.