Source: The post RBI reviews inflation targeting framework and transparency has been created, based on the article “RBI must keep inflation firmly in its crosshairs” published in “Live Mint” on 25th August 2025. RBI reviews inflation targeting framework and transparency.
UPSC Syllabus Topic: GS Paper 3- Indian Economy and issues relating to Planning, Mobilization of Resources, Growth, Development and Employment.
Context: RBI’s discussion paper, issued last Thursday in its five-year review, seeks feedback on four questions about India’s monetary policy framework. The focus is whether flexible inflation targeting (FIT) needs refinement, and how operations and transparency can support credibility and growth stability.
For detailed information on India’s inflation targeting framework has delivered stable outcomes read this article here
Choosing the Inflation Indicator
- Headline over core: The DP favours headline inflation. For India, targeting core is weak since food matters for many households.
- Weight of food in CPI: Food’s weight is about 46% for a large number. Ignoring it would miss the prices that matter most.
- Anticipated CPI update: A CPI recast using 2023–24 HCES is underway, replacing 2011–12 data. As weights change, food volatility’s impact should ease.
Target Level and Tolerance Band
- Keeping the 4% anchor: The DP supports status quo. The 4% target balances growth and stability in a fast-growing economy.
- Evidence from the FIT period: Despite the pandemic and later spikes, average inflation since 2016 is 4.9%, versus 6.8% before FIT. The framework has worked.
- Retaining the 2–6% band: A ±2 percentage-point band (2–6%) gives the MPC flexibility to prioritize inflation or growth as conditions evolve.
Point Target versus Only a Range
- Maintain the 4% point target: Dropping the point target for only a range may dilute the framework and erode credibility.
- International reference: New Zealand used a range for 12 years before adopting a point target. The DP advises India not to shift to range-only.
Operational Improvements and Transparency
- Align rate and liquidity actions: End the dichotomy where repo hikes coincided with liquidity easing, which blunted transmission.
- Report breaches publicly: When inflation exceeds 6% for three consecutive quarters, RBI must report to government. There is no mandate to publish. The last breach—five quarters from Q4 2021–22 to Q4 2022–23—was not released.
- Evolving capacity: FIT remains work-in-progress. Institutional memory is developing, and financial markets are shallow by global standards. Overall, FIT has served India well, and each review is an opportunity to improve.
Question for practice:
Examine why the RBI discussion paper supports retaining a 4% inflation target with a 2–6% tolerance band under India’s FIT framework.
