Flexible Inflation Targeting (FIT): RBI Framework, 4% CPI Target & Monetary Policy Explained

The government  asked the Reserve Bank to target retail inflation at 4% with a margin of 2% on either side for another five years ending March 2031.

• According to the notification, the inflation target is 4% with an upper tolerance level of 6% and a lower tolerance level of 2%.
• India adopted the inflation-targeting framework and formally tasked the central bank with it in 2016.

About Flexible Inflation Targeting (FIT)

• Flexible Inflation Targeting (FIT) is a monetary policy framework in which a central bank aims to keep inflation within a specified target range, while also giving due consideration to economic growth and employment.
• Benchmark: The framework uses the Headline Consumer Price Index (CPI) (base year 2024) as the main benchmark to measure and track inflation in the economy.
• Legal Framework: Section 45-ZA of the amended RBI Act, 1934 states that the primary aim of monetary policy is to ensure price stability, while also taking into account the objective of economic growth.
• Global Context: First adopted by New Zealand in 1990. Now followed by several countries as a key approach to monetary policy.
• The Monetary Policy Committee (MPC) meets at least four times a year to determine the repo rate, which is the rate at which the Reserve Bank of India lends to commercial banks, in order to regulate inflation.
• India’s Adoption: In 2015, RBI and the Government of India agreed on a policy framework prioritizing price stability with growth considerations.
  • The Flexible Inflation Target (FIT) framework was formally adopted in 2016.
  • The RBI Act, 1934 was amended to give it legal backing. 
  • Target Setting: Under the RBI Act, the GoI, in consultation with the RBI, determines the inflation target in terms of the Consumer Price Index (CPI) every five years.
  • Current CPI inflation target: 4% ± 2% (range of 2% to 6%), valid until March 2026.

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Key Features 

• Clear Inflation Target: Under FIT, the central bank operates with a clearly defined inflation target, which provides a nominal anchor for the economy. In India, the target is 4% with a tolerance band of ±2%.
  • For Example: When inflation rose above 6% during 2022–23, it breached the upper limit, triggering policy tightening.
• Use of Monetary Policy Instruments: The central bank uses tools such as repo rate, reverse repo rate, and open market operations to control inflation.
  • For Example: The Reserve Bank of India increased the repo rate from 4% to 6.5% (2022–23) to curb rising inflation.
• Flexibility in Approach: FIT allows temporary deviation from the inflation target to support growth and stability during crises.
  • For Example: During the COVID-19, RBI kept interest rates low despite inflation risks to support economic recovery.
• Medium-Term Orientation: The framework focuses on controlling inflation over the medium term rather than reacting to short-term shocks.
  • For Example: RBI often looks through temporary food price spikes (like onion price surges) instead of tightening policy immediately.

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