Inflation Targeting Framework

Why in the News?

• In December, India’s retail inflation (CPI) hit a three-month high of 1.33%, while a “high” usually suggests rising prices, this figure presents a unique challenge for policymakers because it remains significantly below the Reserve Bank of India’s (RBI) lower comfort level of 2%.
• Simultaneously, core inflation (which excludes volatile food and fuel) sits at a 28-month high of 4.8%, indicating a stark divergence between headline numbers and underlying economic pressures.

1. What is Inflation Targeting?

• A monetary policy framework in which the central bank aims to keep inflation within a specified target range.
• In India, ITF focuses on Consumer Price Index (CPI) inflation.

2. Legal Basis in India

• Introduced through the Finance Act, 2016.
• Amended the Reserve Bank of India Act, 1934.
• Inserted Section 45ZA–45ZK in the RBI Act.

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3. Inflation Target in India

• Target Inflation Rate: 4%
• Tolerance Band: ± 2%
• Effective Range: 2% – 6%
• Target is fixed for a 5-year period by the Government of India in consultation with RBI.
• Current Target Period: 2021–2026

4. Price Index Used

• Consumer Price Index (CPI)
• Not WPI (Wholesale Price Index).

5. Monetary Policy Committee (MPC)

• Constituted under RBI Act, 1934
• Composition (6 Members):
• 3 from RBI: RBI Governor (Chairperson), Deputy Governor (Monetary Policy), One RBI nominee
• 3 external members: Appointed by Central Government
• Decision Making:

• Decisions by majority vote
• In case of tie Governor has casting vote

6. Role of MPC

• Determine policy repo rate
• Aim to achieve the inflation target
• Meet at least 4 times a year (usually 6 meetings)

7. Failure of Inflation Target

• Inflation target is considered failed if: CPI inflation is above 6% or below 2% for 3 consecutive quarters
• RBI must submit a report to Government stating: Reasons for failure, remedial actions, timeframe to achieve target.

8. Objectives of Inflation Targeting

• Maintain price stability
• Anchor inflation expectations
• Promote macro-economic stability
• Support growth in the long run

9. Criticisms / Limitations

• CPI heavily influenced by food & fuel prices
• Limited control over supply-side shocks
• May constrain RBI’s ability to support growth during downturns

10. Frequently Asked Prelims Traps

•  Inflation target is not decided by RBI alone
• WPI is not used
• Target is not flexible beyond ±2%
• MPC is not a constitutional body

Q1. With reference to the Inflation Targeting Framework in India, consider the following statements:
1.	It was introduced through an amendment to the Reserve Bank of India Act, 1934.
2.	The inflation target is fixed by the Reserve Bank of India alone.
3.	Consumer Price Index (CPI) is used to measure inflation under this framework.

Which of the statements given above is/are correct?
(a) 1 and 3 only
(b) 2 and 3 only
(c) 1 only
(d) 1, 2 and 3

ANSWER: (a)
Statement 1 is correct. The Inflation Targeting Framework (ITF), or Flexible Inflation Targeting (FIT), was introduced through the 2016 amendment to the Reserve Bank of India Act, 1934, providing statutory backing after the 2015 Monetary Policy Framework Agreement between the Government of India and RBI.
Statement 2 is incorrect. The inflation target (4% CPI with ±2% band) is determined by the Government of India in consultation with the RBI, not by the RBI alone, and reviewed every five years (current: 2021-2026).
Statement 3 is correct. CPI (headline inflation, including food and fuel) serves as the measure for the target.

Practice Today’s MCQs

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