India Must Hold the Inflation Target Line

The Reserve Bank of India (RBI) has initiated the second statutory review of the flexible inflation targeting (FIT) framework it has used since 2016.

- AMARENDU NANDY

Its recent discussion paper seeks public feedback on whether FIT, which has anchored the Monetary Policy Committee's (MPC's) decisions for nearly a decade, remains relevant for India's economy.

The paper raises four questions: Should the RBI target headline or core inflation, given food's dominant weight in retail price index? Is the 4 per cent inflation target with a tolerance band (+/- 2 per cent) still appropriate for a fast-growing economy? Should the tolerance band be adjusted or scrapped entirely? And should the point target give way to a more flexible range-based approach?

To answer, it is useful to understand what the framework has delivered. Since May 2016, headline inflation has averaged just around 4.8 per cent. Expectations, once volatile, have become more stable. The median one-year-ahead inflation expectation has declined significantly from earlier double-digit peaks towards a narrower range of 8 to 10 per cent. Even when price pressures surged above 6 per cent—in 2019, when onion prices spiked, during the Covid-19 pandemic, and after Russia's invasion of Ukraine—the RBI's Inflation Expectations Survey of Households (IESH) shows that expectations remained strongly anchored. That is no small achievement. FIT has ended India's long cycle of inflation surges and stop-go monetary policy.