The RBI is reviewing how it targets inflation in its monetary policy. It has, however, made a compelling case for sticking with current targets. In a discussion paper released on Thursday, the RBI asked for public feedback on four questions: should headline or core inflation guide policy; is 4% still the right target; should the +/-2% band be adjusted; and should the fixed 4% midpoint be replaced by a simple range of 3-6%. Responses are due by September 18th.
The review, which is set to conclude in March 2026, is the second formal assessment of the flexible inflation-targeting (FIT) framework since its adoption in 2016, and it follows a global trend of central banks consulting more openly on policy.
Key Highlights
- RBI invites public input on its 4% inflation target framework amid scheduled review ahead of 2026.
- Despite openness to suggestions, RBI signals preference to retain current 4% headline inflation target and tolerance band.
So far, the RBI has concluded that FIT was effective. Since 2016, average inflation has fallen to 4.9% from 6.8% in the pre-FIT years, while volatility has decreased from 2.3% to 1.5 percent. The framework held up during the pandemic and again during the Ukraine war, when inflation surpassed the 6% mark. In both cases, the Monetary Policy Committee (MPC) was able to shift priorities, first promoting growth and then quickly reining in prices.
New uncertainties, such as climate change, volatile commodities, shifting global finance, and payment innovations, are putting a strain on the framework.
Also Read: SBI Research: Further RBI Rate Cuts Unlikely in 2025 as Inflation Hits 98-Month Low
The case for maintaining headline inflation is strong. Food and fuel account for more than half of India's consumption basket; excluding them would make the index less representative. The RBI also claims that excluding food inflation would ignore the welfare of the poor, for whom food dominates household budgets. Persistently high food prices influence public expectations and can lead to core inflation. Raghuram Rajan, a former RBI governor, has warned that excluding food could undermine public trust. Empirical evidence indicates that food and fuel prices tend to converge with core inflation over time, making them too important to ignore.
The paper reaffirms the logic behind India's 4% inflation target and +/-2% tolerance band. The 4% midpoint is supported by evidence that fast-growing economies, thanks to the Balassa-Samuelson effect, can tolerate slightly higher inflation. The wide band is justified by India's unusually high food price index.
