India’s inflation targeting framework has delivered stable outcomes

Source: The post India’s inflation targeting framework has delivered stable outcomes has been created, based on the article “Easy regime to communicate” published in “Financial Express” on 5th July 2025

UPSC Syllabus Topic: GS Paper2- Indian Economy and issues relating to Planning, Mobilization of Resources, Growth, Development and Employment.

Context: India adopted a Flexible Inflation Targeting (FIT) framework in 2015–16 to improve the effectiveness of its monetary policy. This article reviews the regime’s performance over the past decade and discusses its future direction amid evolving macroeconomic conditions.

For detailed information on Inflation Management in India- Challenges and Way Forward read this article here

Challenges of Pre-FIT Monetary Policy

1. Weak Transmission Mechanism: In the pre-FIT era, India’s monetary policy faced limited effectiveness due to fiscal dominance, a large informal sector, and rigid bank lending practices.
2. Institutional Reforms for Support: In the last decade, RBI, the government, and banks have made significant efforts to address these constraints, paving the way for a more responsive policy system.

Performance of FIT Over the Decade

1.,Inflation Stability: Since adopting FIT, CPI and core inflation have mostly stayed within the 2–6% band, except during the COVID-19 period, when supply shocks and liquidity infusion pushed inflation above the target.

2. Anchoring Expectations: Despite occasional breaches, inflation expectations remained anchored, especially until mid-2023, after which a rapid correction followed.
3. Effective Flexibility in Practice: The RBI’s flexible approach—tolerating temporary breaches—worked well given the forecasting uncertainties and policy transmission lags.
4. Global Benchmarking: Between 2021–2024, India had one of the lowest deviations from its inflation target among major economies, reinforcing FIT’s credibility.

Key Factors Behind FIT’s Effectiveness

1. Macro Stability with Flexibility: Like Australia, India used monetary policy to stabilize output while containing inflation. Average headline and food inflation remained at 4.9%.
2. Anchored Long-Term Expectations: Post-2016, expectations became less reactive to short-term inflation sentiment, showing the impact of FIT on credibility.
3. Food Inflation’s Role: Studies confirm that food-price shocks can de-anchor expectations and influence core inflation, supporting the case for targeting headline CPI over core.

Debates on FIT’s Future

1. Diverging Proposals: Some suggest shifting to core inflation targeting; the Economic Survey echoes this view, but an RBI internal committee recommends retaining the current framework.
2. Issues with Core CPI Targeting: Core CPI includes services like education, healthcare, and non-discretionary items that are less responsive to policy changes and may distort guidance.
3. Communication Advantage of CPI: CPI is easier to communicate and more relatable for the public, helping anchor expectations more effectively than core CPI.

Recommendations Going Forward

1. Maintain the Current Band: The current target of 4% with a ±2% band is suitable. Narrowing it may conflict with external sector realities.
2. Avoid Drastic Changes: Given the RBI’s gained credibility, any major shift now could be counterproductive, especially amid high policy uncertainty. FIT should continue until 2031, with changes only if clearly justified and communicated.

Question for practice:

Discuss the effectiveness of India’s Flexible Inflation Targeting (FIT) framework over the past decade and the key considerations for its future direction.