Mentor’s Comment

The debate on India’s Flexible Inflation Targeting (FIT) framework is central to macroeconomic stability, especially as the Reserve Bank of India (RBI) undertakes the second quinquennial review after adopting FIT in 2016. This article decodes the logic, data trends, inflation-growth dynamics, concerns over inflation bands, and the evolving economic context, translated into UPSC-ready analysis with conceptual clarity.

Introduction

India adopted the Flexible Inflation Targeting (FIT) framework in 2016, giving statutory autonomy to the RBI for price stability. With the current inflation band of 4% ± 2% up for review in March 2026, economic debate has intensified on whether this band remains appropriate amid structural shifts, supply-side shocks, and the inflation-growth trade-off. The article evaluates India’s experience with FIT, evidence from inflation-growth relationships, and the question of acceptable inflation levels for sustained macroeconomic stability.

Why in the News?

The FIT framework is undergoing its second major review since its inception in 2016, making it a crucial moment for India’s monetary policy architecture. RBI has released a research discussion paper, its most comprehensive assessment yet, presenting long-term inflation-growth data, the first such empirical mapping since 1991. The debate is significant because India’s inflation has remained near the upper tolerance band, raising questions about whether 4% is still an appropriate central target or whether persistent supply shocks require rethinking the framework. The outcome of this review will shape India’s monetary autonomy, fiscal-monetary coordination, and growth stability over the coming decade.

What makes inflation control central to monetary policy?

1. Inflation as a regressive tax: Disproportionately burdens poorer households whose incomes are not hedged; erodes purchasing power.
2. High inflation leading to misallocation of resources: Leads to volatile investments and misdirected economic decisions.
3. Acceptable inflation evolves with context: The Chakravarty Committee (1985) recommended 5% as acceptable, but economic conditions have since changed.
4. Institutional strengthening since 1994: Post-automatic monetisation era gave RBI functional autonomy; FIT (2016) gave statutory backing for price stability.

How does India’s current FIT framework work?

1. Inflation band of 4% ± 2%: Offers flexibility while anchoring expectations.
2. Headline inflation as target: Encourages investment protection from supply shocks; aligns with international norms.
3. Range-bound inflation despite shocks: India has broadly maintained inflation within the band, reflecting maturing policy credibility.
4. Mechanism evolves with economic complexity: Framework still young, but institutional autonomy makes it robust.

What should India target-headline inflation or core inflation?

1. Headline inflation captures supply shocks: Essential in an economy where food inflation significantly affects households.
2. Misconception on price behaviour: General price level (inflation) differs from relative price changes (e.g., wages, food).
3. Milton Friedman example: Excess money supply raises general prices; changing relative prices without liquidity expansion cannot cause inflation.
4. No liquidity expansion leading to no general inflation: Relative price movement alone insufficient to generate sustained inflation.

What does long-term data reveal about inflation and growth?

1. Quadratic inflation-growth curve (1991-2023): Presented in the article; first time excluding COVID years.
2. Point of inflection = 3.98%: Growth rises with inflation to ~4%, then declines beyond it.
   1. Implication: India’s acceptable inflation level is just around 4%.
3. Higher inflation hurts growth: Especially when supply constraints, fiscal stress, and external pressures coincide.

How flexible should the inflation band be

1. FIT performance so far: Delivered flexibility; monetary authorities operate near upper limit due to shocks.
2. Risk of staying at the upper band: May undermine framework credibility.
3. Policy navigation matters: India earlier faced high inflation in the 1970s-80s; monetisation of the deficit made it worse.
4. Present framework avoids past mistakes: Moves away from fiscal dominance; prevents automatic deficit monetisation.

What determines an acceptable level of inflation?

1. Phillips Curve insights: Countries with higher income also see higher acceptable inflation levels.
2. Empirical threshold near 4%: RBI paper’s curve suggests growth maximisation at around 4%.
3. India-specific vulnerabilities: Supply shocks (food, fuel), climate variability, imported inflation, fiscal constraints.
4. Need for robust expectations anchoring: Prevents wage-price spiral and demand misalignment.

Conclusion

India’s Flexible Inflation Targeting has broadly succeeded in stabilising inflation expectations while preserving monetary autonomy. Evidence from long-term inflation-growth dynamics reinforces that 4% remains an optimal central target, though India must build greater resilience to supply shocks and strengthen fiscal-monetary coordination. A credible, flexible, and data-driven FIT framework remains essential for India’s growth trajectory over the next decade.

PYQ Relevance

[UPSC 2024] What are the causes of persistent high food inflation in India? Comment on the effectiveness of the monetary policy of the RBI to control this type of inflation.

Linkage: This PYQ  is highly relevant as food inflation heavily shapes headline inflation under the Flexible Inflation Targeting (FIT) framework, highlighting the limits of the Reserve Bank of India’s (RBI) tools. It links to the review of the four-percent target and RBI’s role in managing supply-driven inflation.

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