India’s inflation targeting framework (FIT) has been in place since 2014-15. It aimed to stabilise inflation and support growth. Recent data show headline consumer price index (CPI) inflation averaged 5 per cent post-FIT, down from 8.5 per cent in the pre-FIT period since the 1970s. Core inflation has remained around 4 per cent since late 2023. Despite this success, challenges remain in fine-tuning FIT to better balance inflation control and economic growth.
Inflation Trends Before and After FIT
Before FIT, India experienced high inflation averaging 8.5 per cent, often in double digits. After FIT introduction, headline inflation dropped to around 5 per cent. Core or trend inflation has been more stable at about 4 per cent. Volatile components of inflation tend to converge to this core rate. This indicates FIT’s success in anchoring inflation expectations and reducing inflation volatility.
Real Interest Rates and Growth Dynamics
Periods of low growth since the 1970s often saw real interest rates above 1.5 per cent, including during FIT years 2017-20 and 2024-25. Excessively high real rates can hinder growth. FIT has sometimes led to tightening that risks slowing the economy. However, removing FIT is not advisable as similar tightening occurred before FIT, such as in the 1990s. High inflation with low real rates also suppressed growth in the 1970s and early 2010s.
Maintaining and Adjusting Inflation Targets
Headline inflation remains the appropriate target due to food’s weight in consumption. Inflation expectations now anchor near 4 per cent, helping price stability. The inflation target range should not be narrowed despite occasional breaches caused by supply shocks. This flexibility allows transient shocks to pass without abrupt policy changes. Public forecasts of core inflation alongside headline inflation could improve expectation management.
Institutional and Policy Enhancements
FIT reduces discretionary policy decisions by individuals. However, institutional memory and continuity in the Monetary Policy Committee (MPC) need strengthening. Staggered MPC appointments can provide stability. Regular updates and rebasing of inflation indices are essential. Call money rates should stay close to the repo rate despite liquidity shocks. Assigning MPC durable liquidity management responsibility could increase transparency and market confidence.
Customising FIT for Emerging Market Realities
India’s FIT follows advanced economy models but requires adaptation. Emerging markets face volatile commodity prices, exchange rate interventions, and segmented markets. Monetary policy must coordinate with fiscal policy, especially for supply-side inflation. Government involvement in commodity price management and long-term productivity improvements is crucial. A strategy for counter-cyclical oil excise taxes could help manage external shocks while reducing oil dependency.
Balancing Price Stability and Growth
The RBI Act mandates price stability while considering growth. The wording could evolve to emphasise maintain price stability while protecting growth to reflect India’s development goals. FIT reviews offer a chance to learn from past experiences and improve the framework. Enhanced public understanding and national debate will strengthen FIT’s effectiveness and acceptance.
Questions for UPSC:
- Critically discuss the role of inflation targeting in achieving macroeconomic stability in emerging economies like India.
- Analyse the impact of real interest rates on economic growth and inflation control in developing countries.
- Examine the challenges of coordinating monetary and fiscal policies to manage supply-side inflation in India.
- Estimate the effects of volatile commodity prices on inflation targeting frameworks and suggest mitigation strategies.
