With the September 18 deadline for submitting views on the Reserve Bank of India’s (RBI) discussion paper on its monetary policy framework fast approaching, former members of the Monetary Policy Committee (MPC) are largely in favour of retaining the targets as per the existing Flexible Inflation Target (FIT) regime and want to continue to focus on keeping headline Consumer Price Index (CPI) inflation at 4 per cent in the medium term.
Officially adopted in August 2016, the CPI inflation target of 4 per cent within a tolerance band of 2-6 per cent is required to be revisited every five years and decided by the Central government in consultation with the RBI. Ahead of its next review, which must be completed by the end of March 2026, the RBI last month released a discussion paper seeking comments on four key questions: should monetary policy be guided by headline or core inflation, if the 4 per cent inflation target remains optimal, should the tolerance band around the target be revised, and should the 4 per cent target be removed and replaced with only a range.
According to Ashima Goyal, Emeritus Professor at Mumbai’s IGIDR and an MPC member from 2020 to 2024, the 4 per cent target should be retained as it has contributed to stabilising the public’s expectations of inflation. However, “the process has further to go and should not be disturbed”, Goyal told The Indian Express.
Ever since the RBI shifted its focus to retail inflation from wholesale in January 2014 to assure households that price rises will be controlled and not rampant, CPI inflation has gradually come down. From almost 10 per cent in 2012-13, average CPI inflation is projected by the RBI to fall to just 3.1 per cent in the current fiscal — the lowest annual average during the FIT regime. Economists expect inflation this year to be even lower at around 2.5 per cent, thanks to a favourable base effect, a good monsoon, and the Goods and Services Tax (GST) rate cuts announced earlier this month.
Low and stable inflation is widely considered crucial to sustaining high economic growth. If prices rise rapidly, consumers’ ability to buy goods and services is eroded; on the other hand, very muted price increases reduce the incentive for producers to keep supplying their goods and services as profits don’t rise enough to compensate them for their effort.
Janak Raj, formerly an executive director at the RBI and a member of the MPC in 2020, is also “not at all in favour of changing anything”. “We should live with it for another five years and see what happens. It’s a safe approach to follow. On the other hand, there are risks if any changes are made to the current numerical target in any manner,” Raj told The Indian Express.
Arguing in an August 2024 paper she co-authored, Deputy Governor Poonam Gupta —
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then the director general of the New Delhi-based think-tank NCAER — had said the inflation targeting regime has “worked well” and a 4 per cent target in a band of 2-6 per cent with a focus on the headline inflation rate “remain broadly appropriate”.
RBI to review monetary policy framework
Officially adopted in August 2016, the Consumer Price Index inflation target of 4% within a tolerance band of 2-6% is required to be revisited every five years and decided by the Central government in consultation with the Reserve Bank of India.
A new target?
To be sure, there are some who want the inflation targets to change, with the most vocal among them being former IIM-Ahmedabad professor Ravindra Dholakia, who served on the MPC from 2016 to 2020. According to Dholakia, India needs to be more “practical” and “pragmatic” in setting its inflation target. In a webinar in October 2024, he argued that an inflation target of 4 per cent was too low and an obstacle to structural changes needed to help India become a developed country, adding that a number around 5.5 per cent is the “right kind of inflation target” for India.
Meanwhile, another former member of the MPC, requesting anonymity, said that given nearly 10 years have passed since FIT was adopted, it is time for India to start thinking of reducing the tolerance band: first by lowering the target to 3.5 per cent and then reducing the range to 2-5.5 per cent from 2-6 per cent.
However, Janak Raj warned that any change to the tolerance band right now would be premature considering CPI inflation had exceeded 6 per cent 28 times and fallen below 2 per cent on three occasions since in the FIT era. Further, in late 2022, the RBI was forced to write a ‘letter’ to the government explaining why it had failed to meet the inflation mandate after average quarterly inflation stayed outside the range of 2-6 per cent for three consecutive quarters. “If inflation over the last nine-ten years has exceeded the upper threshold of 6 per cent so many times, then there is no case to reduce the range or target. The credibility of the FIT and the RBI will be at risk if we are not able to achieve the target,” Raj said.
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What about food?
The 2023-24 Economic Survey, presented in July 2024, has over the last year or so sparked a debate on whether the RBI should target headline inflation or an inflation rate that excludes food items. The Survey had said that given the high weight of the food items in the CPI — almost 46 per cent — it was worth exploring if inflation excluding food should be the target, since food prices are not controlled by interest rate changes but supply-side actions of the government. However, the RBI under the then governor, Shaktikanta Das, had fought back, saying food prices could not be ignored by the monetary authority.
