In 2016, India officially embraced an inflation targeting (IT) framework under the amended Reserve Bank of India Act, 1934. It directed a medium-term inflation target of 4% with a tolerance band of ±2% (2%–6%), to be reviewed every 5 years.
A Monetary Policy Committee (MPC) was formulated to set policy rates, ensuring transparency, accountability, and mutual decision-making. The second review, which will take place next year, the RBI has released a discussion paper assessing the entire thing.
Why Inflation Targeting?
(i) High Inflation Legacy: India’s average Consumer Price Index inflation was around 10% in 2010–13, leading to macroeconomic instability.
(ii) Credibility Gap: Prior to IT, monetary policy did not have a clear nominal anchor.
(iii) Global Best Practice: Around forty-eight nations, including the United Kingdom, New Zealand, as well as Brazil, adopted it with success.
(iv) Need for Balance: This method ensures a structured way to maintain equilibrium among growth, price stability, and unexpected shocks.
Achievements of India’s Inflation Targeting Regime
(i) Price Stability: Average CPI inflation since 2016 has come down from nine per cent to around seven per cent in the pre-IT period. Escalation expectations of households and companies have shown signs of anchoring.
(ii) Accountability: If escalation crosses the 2–6% band for 3 continuous quarters, the Reserve Bank of India has to explain to the dispensation. For eg, in 2022, this 6% mark was breached, so the RBI gave a detailed report about the reasons and corrective measures.
(iii) Transparency: Monitory Policy Committee minutes (published after 14 days) disclose every member’s rationale, ensuring policy credibility.
(iv) Flexibility in Crisis: During COVID-19, the MPC gave preference to growth without neglecting inflation. This approach balanced India’s comeback with financial stability.
(v) Institutional Reform: Shift from “Governor-centric” policy to a committee-based approach, taking various multifaceted perspectives.
Criticism of India’s Inflation Targeting
(i) Overemphasis on Inflation: Some say that IT avoided growth and employment objectives, specifically in developing countries.
(ii) Food and Fuel Driven Inflation: The Supply side of food and fuel is the reason for India’s inflation, with very little influence of monetary policy.
(iii) Conflict with Fiscal Policy: Spending extravagantly (higher deficits, subsidies) can undermine IT, as witnessed during the pandemic.
(iv) Transmission Challenges: High non-performing assets (NPAs) and structural issues affect monetary transmission efficiency negatively.
(vi) Risk of Policy Rigidity: A strict IT regime may lead to pro-cyclical tightening during supply shocks, hurting growth.
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Way Forward
(i) Retain 4% Target: Any upward revision may destroy policy credibility and increase borrowing costs.
(ii) Maintain ±2% Band: Ensure required flexibility for supply shocks.
(iii) Strengthen Coordination: Better cooperation between monetary and fiscal policy to lessen inflationary stress.
(iv) Improve Transmission: Scaling bond markets, time-bound rate pass-through in banks, and recovering NPAs.
(v) Structural Reforms: Invest in agriculture supply chains, energy diversification, and logistics to reduce supply-side inflation.
(vi) Build Credibility: Avoid frequent revisions in the target; continue publishing MPC minutes for transparency.
(vii) Strengthen Communication: RBI must actively guide inflation expectations through public communication.
Conclusion
India’s transition to an inflation-targeting framework in 2016 has been successful in reducing escalation and increasing credibility. The review, which is going to come, must balance policy certainty with flexibility, maintaining the credibility built over the past nine years.