UPSC Syllabus Topic: GS Paper 3 –Inflation
Introduction
India uses inflation targeting to guide monetary policy, but recent experience shows sharp price swings and mixed results. Food inflation has shifted strongly, while repo rate changes often looked weak. As the current flexible inflation targeting framework ends in March 2026, India must reassess what has worked, where it falls short, and how it should evolve.
India’s Flexible Inflation Targeting (FIT)
- Origin: In 2016, India adopted the Flexible Inflation Targeting (FIT) framework with a 4% inflation target and a tolerance band of +/- 2%, and gave institutional autonomy to monetary policy through the Monetary Policy Committee.
- Objectives and macro-fiscal context
- Under Flexible Inflation Targeting (FIT), policy aims to keep inflation near 4% within the 2%–6% band to protect savings and investment and curb the regressive impact of high inflation on poorer households.
- Earlier inflation from monetised deficits led to ending ad hoc treasury bills and adopting the Fiscal Responsibility and Budget Management (FRBM) Act to discipline fiscal policy and support price stability.
Performance: Inflation has been more range-bound after 2016. However, annual average CPI inflation has exceeded 4% in six of nine FIT years, so the target has not been met consistently.
Concerns with the current inflation targeting framework
- Limited impact of monetary policy on core inflation
• Core inflation excludes food, fuel, petrol and diesel and has a weight of 45% in the CPI basket. It has often stayed above 4% even when headline inflation has fallen below 2%.
- This pattern suggests that repo rate changes have not clearly reduced core inflation, and claims of bigger impact under FIT remain unproven.
- Headline versus core inflation and use of the band
- Headline inflation, which includes food prices, is more relevant to protect savings, investment and the poor. Food and headline inflation move together, with a correlation of 0.89, showing that food prices dominate CPI.
- The target of 4% with a 2%–6% band gives flexibility, but if inflation stays near 6% for long, it weakens both the framework and growth.
- Studies find that the inflation–growth relationship changes around 3.98%, which supports using 4% as the central target for India.
- Distributional impact and inflation expectations: Lower-income households feel inflation more when food prices rise, so their expectations are strongly shaped by food inflation. Anchoring expectations, therefore, needs sustainably low and less volatile food inflation.
Way forward
- Continue targeting headline inflation: Headline CPI should remain the main target in India because it reflects the price changes that households actually face, especially poorer groups.
- Place food inflation at the centre of policy: Food inflation drives headline CPI and strongly shapes what people expect about future inflation. Keeping food inflation low and less volatile needs better storage, logistics, market integration, buffer stocks, and suitable trade and stock policies, which lie mostly outside conventional monetary policy.
- Ensure shared responsibility of RBI and government: Inflation control must be a joint task. The RBI should use interest rates and communication under FIT, while the government acts on supply, especially food and other key items, keeping income distribution in mind.
- Align inflation targeting with fiscal rules: Flexible Inflation Targeting (FIT) must work together with FRBM like fiscal discipline so that deficits and government borrowing do not create persistent inflation and undermine the 4 % target.
Conclusion
India’s inflation targeting framework has given structure and autonomy to monetary policy, but its success is uneven and heavily dependent on food prices. Evidence on durable core inflation control and firm expectation anchoring remains limited. The next framework must keep headline targeting, manage food inflation, align fiscal rules and shield poorer households from the costs of inflation.
Question for practice:
Discuss the effectiveness and limitations of India’s current inflation targeting framework in light of recent trends.
Source: Businessline
