The Reserve Bank of India (RBI) has recently initiated a public consultation to review its Monetary Policy (MP) framework ahead of March 2026. The focus is on formulating an optimal inflation policy rule that balances inflation control with economic growth amid rising global uncertainties. This review comes nearly a decade after India adopted the Flexible Inflation Targeting (FIT) framework in 2016, which set a Consumer Price Index (CPI) inflation target of 4 per cent with a tolerance band of 2-6 per cent.
Background of Inflation Targeting in India
India shifted to the FIT regime in 2016, aligning with global central banks’ practices. The target set was a 4 per cent CPI inflation rate, allowing a range between 2 and 6 per cent. This approach aimed to anchor inflation expectations and enhance transparency and credibility of the monetary authority. Since then, inflation volatility has reduced, and average inflation has been relatively lower compared to earlier periods.
Challenges in Inflation Control
India’s inflation is often driven by supply-side shocks such as fluctuating food and fuel prices, weather events, and global commodity price changes. These factors limit the effectiveness of traditional monetary policy tools in directly controlling inflation. Global economic shocks, including US tariff policies and geopolitical tensions, add further complexity. This raises questions about whether the RBI should continue targeting headline inflation or shift focus to core inflation, which excludes volatile food and fuel prices.
Growth Versus Inflation Debate
There is an ongoing debate on whether monetary policy should prioritise growth over inflation control. Recent reforms such as the Goods and Services Tax (GST) aim to stimulate consumption and investment, potentially increasing inflationary pressures. Policymakers face the challenge of supporting short-term economic expansion without compromising medium-term inflation stability. Balancing these objectives is critical for sustained economic health.
Proposed Changes in Inflation Targeting Framework
Experts suggest maintaining the 4 per cent inflation target but allowing more flexibility in the tolerance band. Given current global volatility, widening the band slightly, for example to 2-6.5 per cent, could provide room to absorb external shocks without frequent policy changes. Once global conditions stabilise, the RBI could revert to the original ±2 per cent band. This approach supports economic resilience and reduces unnecessary market disruptions.
Focus on Headline Inflation
The RBI is advised to continue monitoring headline inflation rather than core inflation. Headline inflation reflects the overall price changes experienced by consumers, including food and fuel. Targeting headline inflation helps prevent speculative reactions and maintains public confidence. It also provides a clearer picture of inflationary pressures affecting the economy.
Monetary Policy Outlook
The RBI’s future MP framework aims to stabilise inflation in the medium term while providing sufficient support for economic growth. This dual objective requires a flexible and adaptive policy stance. The central bank must carefully weigh inflation control against the need for expansionary measures during periods of economic stress. The ongoing consultation process seeks inputs to fine-tune this balance.
Questions for UPSC:
- Point out the challenges faced by central banks in controlling inflation caused by supply-side shocks, with suitable examples from India.
- Underline the role of the Reserve Bank of India’s Flexible Inflation Targeting framework since 2016 and critically analyse its impact on inflation volatility.
- What is the Goods and Services Tax (GST) reform? How does it influence inflation and economic growth in India?
- Estimate the importance of balancing inflation control and economic growth in a developing economy, and discuss the potential risks of prioritising one over the other.
