The Reserve Bank of India (RBI) cautioned against raising the current 4% inflation target, saying it could weaken policy credibility and undo the gains of the past decade.

• The RBI released its discussion paper (August 2025) on reviewing the flexible inflation targeting (FIT) framework.

Highlights from the Paper

• Target Adjustment Concerns: Raising the inflation target amid global uncertainty may signal dilution of the framework, reducing investor confidence.
• Empirical Evidence: Headline inflation in India has ranged 1.5–8.6% since 2014, mostly driven by food. Core inflation has been relatively stable, but non-core shocks spill into core over time.
• Global Practice: Almost all inflation-targeting central banks focus on headline CPI, with Uganda being the only exception (targets core inflation).
• Investor Confidence: Keeping inflation within the 2–6% band has strengthened investor confidence, supported growth, and ensured currency stability.
• Global Recognition: S&P Global Ratings recently upgraded India’s rating to BBB, citing RBI’s consistent record in inflation management.

Key Issues in the Discussion Paper

• Target Variable
  • Should policy target headline inflation (includes food and fuel) or core inflation (excludes volatile items)?
  • Economic Survey 2023–24 suggested targeting core inflation, since food inflation is often supply-driven.
  • RBI argues that headline inflation must remain the target, since food inflation spills over into core inflation via wages, rents, and expectations.
• Optimal Inflation Target
  • The current 4% midpoint target balances price stability and growth.
  • Raising targets above 4% may dilute credibility, appear as a weakening of fiscal-monetary discipline, and worry global investors.
  • Lowering below 4% is seen as inappropriate for India’s stage of development.
• Tolerance Band (2–6%)
  • Question whether this band needs to be narrowed, widened, or scrapped.
  • RBI stresses the need for policy certainty and credibility, especially under global uncertainties.
• Range versus Point Target
  • Debate on whether India should continue with a point target (4%) with a band (2–6%), or shift to a pure range target.

About Inflation Targeting

• Definition: Inflation targeting is a monetary policy framework where the central bank adjusts monetary tools to maintain a specified annual inflation rate, ensuring price stability.

• Global Context: First adopted by New Zealand in 1990. Now followed by several countries as a key approach to monetary policy.
• Significance: Provides clear guidance for central banks.
  • It influences Interest rate decisions: Rates are increased when inflation or GDP growth exceeds desired levels and vice versa.

• 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.

Achievements of inflation targeting in India

• Price Stability: Helped bring down double-digit inflation to more manageable levels.
• Transparency & Accountability: Made RBI’s monetary policy framework clearer and more responsible.
• Anchored Expectations: Stabilized inflation outlook for businesses and consumers, reducing uncertainty.
• Global Credibility: Enhanced India’s monetary reputation and policy credibility on the international stage.

Monetary Policy Committee

• Purpose: Established under the MoU between the Government of India and RBI for inflation-targeting framework.

• Legal Basis: RBI Act, 1934 amended by Finance Act, 2016; Section 45ZB empowers government to constitute MPC.
• Function: Sets benchmark policy rate (repo rate) to maintain inflation within target.
• Meeting Quorum: A quorum of four members is required for an MPC meeting, including at least the Governor or, in their absence, the Deputy Governor responsible for monetary policy.
• Decision-Making: Decisions are made by majority vote. In the event of a tie, the RBI Governor holds the casting vote. MPC decisions are binding on the RBI.
• Support Structure: The RBI’s Monetary Policy Department (MPD) provides assistance to the MPC in formulating monetary policy.
• Accountability: If inflation breached 6%, the RBI need to submit a report to the government explaining causes and corrective actions.

Limitations of Inflation Targeting

• Growth Trade-off: Prioritizing inflation control often leads to slower growth, reduced investment, and weaker job creation.
• External Shocks: Wars, pandemics, or global disruptions make inflation targeting less effective.
• Monetary Dependence on Government: Heavy reliance on food in India’s CPI means RBI depends on government supply-side measures (e.g., duty cuts on edible oils), reducing its autonomy.
  • In the last one year, the effective import duty on crude and refined palm oil has come down from 30.25% and 41.25% to 5.5% and 13.75%, respectively. It’s been even sharper — from 30.25% to nil — for crude soyabean and sunflower oil.
• No Clear Link to Financial Stability: The 2008 Global Financial Crisis revealed that emphasizing price stability alone does not ensure financial stability. Overreliance on price stability can neglect regulatory functions, potentially leading to crises.
• Ineffective for Supply-Side Inflation: Inflation in India often stems from supply-side issues like rising oil prices or weather-related disruptions. In such cases, the central bank’s ability to influence inflation is limited, requiring government intervention.
• High Interest Rates: Tight monetary policy discourages private investment, hampers exports, and slows GDP growth.
• Overlooks Wider Role of RBI: Sole focus on price stability sidelines the central bank’s responsibilities of promoting growth, employment, and financial stability.

Way Forward

• Continue with headline CPI-based targeting at 4% with a 2–6% band, ensuring policy continuity.
• Strengthen supply-side management of food and fuel inflation through government measures.
• Enhance communication strategy of RBI to anchor expectations during volatility.
• Explore gradual refinement of CPI basket (due for revision in 2026) to better reflect consumption patterns.
• Balance growth–inflation trade-off by coordinating fiscal and monetary policies.

Conclusion

The conduct of monetary policy requires both certainty and credibility, especially in today’s environment of global and domestic uncertainties. Hence, India must continue with the proven framework of flexible inflation targeting, preserving its core principles while making gradual refinements to ensure price stability, growth, and financial resilience.

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