The Reserve Bank of India (RBI) is reviewing its monetary policy framework, specifically its inflation targeting strategy, which has been in place since 2016. The current framework aims to achieve a 4% headline inflation rate, with a tolerance band of ±2 percentage points. The RBI has sought feedback on whether to continue with this target or shift focus to core inflation, which excludes volatile food and fuel prices.
Inflation targeting is a modern monetary policy framework where a central bank publicly commits to achieving a specific annual inflation rate. This approach aims to anchor public inflation expectations, ensuring price stability, which supports sustainable economic growth. The RBI’s existing framework has served India well, with the average inflation rate since 2016 being 4.9%, a significant improvement from the 6.8% average earlier.
The RBI argues that headline inflation is more relevant to the average household’s cost of living, as food and fuel are major expenses. However, critics argue that sudden shocks in these sectors can push inflation outside the target band, potentially undermining the RBI’s credibility or forcing an overreaction in policy. The RBI has reaffirmed its belief that the existing framework has served India well, but is open to refinements.
Inflation targeting promotes transparency and credibility, anchors expectations, and offers flexible discretion. It allows central banks to respond to economic shocks, such as a recession, by balancing the primary goal of price stability with other concerns like economic growth and employment. The RBI’s Monetary Policy Committee is entrusted with the task of achieving the inflation target, primarily by adjusting short-term interest rates.
The RBI is also considering updating its Consumer Price Index (CPI), which is currently based on the 2012 basket of goods and services. The proposed new CPI will update expenditure weights, include a wider range of services, and better reflect rural-urban consumption differences. Global central banks, such as the US Federal Reserve and the Bank of England, follow a similar approach, focusing on headline CPI for their targets while constantly analyzing core inflation to understand underlying trends.
The final decision on the RBI’s inflation targeting strategy will balance the proven effectiveness of the current framework with the need for adaptability in a changing global economy. Whether the future involves a refined focus or a new approach, one thing is clear: inflation targeting will remain a central pillar of India’s economic management. The RBI’s review of its monetary policy framework is a crucial step in ensuring that the country’s economic stability is maintained, and its growth trajectory is supported.