[Answered] Evaluate Flexible Inflation Targeting (FIT) as a balanced monetary policy framework. Justify the necessity of deriving acceptable inflation rates consistent with India’s growth prospects and macro conditions.

Introduction

India’s 2016 adoption of Flexible Inflation Targeting (FIT) stabilised inflation despite global shocks, with CPI inflation averaging near 4.5%. As RBI reviews the framework for 2026, recalibrating acceptable inflation consistent with growth becomes crucial.

What is Flexible Inflation Targeting (FIT)?

1. Flexible Inflation Targeting (FIT) represents a calibrated approach to price stability, giving the Reserve Bank of India autonomy to anchor inflation expectations while accommodating growth impulses.
2. The current 4% ±2% target, introduced through the Monetary Policy Framework Agreement (2016), has helped India maintain macroeconomic stability even amid supply shocks, COVID-19 disruptions, and global geopolitical volatility.

FIT as a balanced monetary policy framework

1. Anchoring inflation expectations: Studies by the RBI and IMF show that post-2016, household inflation expectations became less volatile. A credible anchor reduces the “inflation tax” on the poor—aligning with the article’s point that high inflation is regressive.
2. Accommodating growth (flexibility component): Unlike strict inflation targeting regimes (e.g., New Zealand in early 1990s), FIT allows Indian monetary policy to consider output gaps, supply shocks, and financial stability. The MPC’s accommodative stance during 2020-22 prevented a deeper recession despite inflation temporarily breaching the 6% upper band.
3. Institutional autonomy & policy discipline: FIT complements FRBM legislation by preventing fiscal dominance. The end of automatic monetisation in 1994 and the FIT regime together reduce risks of “fiscal inflation” characteristic of the 1970s-80s.
4. Clarity on headline vs core inflation: As the article notes, targeting headline inflation is logical because food inflation often triggers second-round effects on wages and core CPI in India. Technical tools like output gap analysis and Phillips Curve estimations strengthen decision-making.
5. Performance during shocks: Despite global commodity shocks, India’s inflation largely stayed within or near the band. World Bank’s 2023 report recognised India as one of the few large economies avoiding double-digit inflation.

Why deriving acceptable inflation rates is essential now

1. Threshold inflation for growth: Empirical studies (RBI 2023, Sarel 1996) indicate that above 4–6% inflation, growth begins to deteriorate. The article’s analysis shows an inflection point at 3.98%, making the current target economically justified.
2. Forward-looking calibration (2026–2031): Deriving an acceptable inflation rate must consider expected fiscal consolidation, global supply chain realignments, climate change-related food shocks, and energy transitions over the next decade.
3. Macroeconomic compatibility: Acceptable inflation must be consistent with:

• External stability: To avoid currency depreciation and imported inflation.
• Financial stability: Preventing excessive credit cycles.
• Investment climate: Predictable prices encourage long-term capital formation.

1. Avoiding target drift: A higher target (e.g., 5–6%) may weaken RBI’s credibility and allow prolonged inflation close to the upper band, risking stagflation. The article rightly notes that staying near 6% undermines FIT’s spirit.
2. Alignment with global best practices: Most credible inflation-targeting economies (UK, Canada, Australia) maintain targets between 2–3%. India, as a supply-shock-prone emerging economy, may justify a slightly higher threshold, but evidence still favours the 4% benchmark.

Needed refinements

1. Clear communication on tolerance duration near upper/lower bands.
2. Stronger monetary–fiscal coordination to avoid policy slippages.
3. Improved high-frequency inflation data, especially for rural markets.
4. Enhanced modelling for climate-sensitive food inflation.

Conclusion

Credible inflation targeting sustains growth. India must refine FIT by deriving realistic, evidence-backed targets aligned with future macroeconomic conditions.