Monetary Policy Committee Notifications

How did inflation targeting really impact India?


From UPSC perspective, the following things are important :

Prelims level: MPC

Mains level: Paper 3- Analysing the performance of inflation targeting policies in India

The article analyses the success of the inflation targeting mechanism in India and its impact on the growth of the economy.

Background of the inflation targeting policy in India

  • It has been three decades since inflation targeting was first adopted in New Zealand and subsequently by 33 other countries.
  • India adopted it in 2016.
  • The primary goal of inflation targeting was to contain inflation at around 4 per cent, within the allowable range of 2 to 6 per cent.
  • The RBI has announced a formal review of the policy instrument now.
  • At the first meeting of the RBI Monetary Policy Committee in October 2016, it was also formally announced that the MPC considered a real repo rate of 1.25 per cent as the neutral real policy rate for the Indian economy.
  • By a neutral real policy rate, the RBI meant a policy rate consistent with growth at potential (i.e. growth at full employment).

Has inflation targeting worked in India

  • The evaluation of IT must provide answers to the following two questions:
  • Did inflation decline post the adoption of inflation targeting and what was the role of IT in the decline in inflation?
  • Was the adoption of inflation targeting associated with the policy of the highest real repo rates in India — ever — for almost three years 2017-2019?
  • The answer is yes to the latter, but it also needs to be acknowledged that high real repo rates were the primary cause of the GDP growth decline in India from 8 per cent to 5 per cent.

Need to take into account the global context of inflation

  • An interesting feature of the Indian defence of inflation targeting is that very few take into account the global context of inflation in which the decline in inflation has occurred in India.
  • A research paper by Balasubramanian, Bhalla, Bhasin and Loungani at ORF evaluates inflation targeting in a global context and separately for Advanced Economies (AEs) and Emerging Economies (EES).
  • Some facts from the paper are the following.
  • First, the annual median inflation in AEs has been consistently low, so low that many central banks have official campaigns to raise the inflation rate.
  • One conclusion might be that IT succeeded beyond anyone’s dreams in these economies.
  • But attributing this decline in inflation to IT would be erroneous.
  • Inflation is global and price-taking by millions of producers in the world means that no one producer or one country can influence the price of any item.
  • Oil has ceased to be a factor in global inflation, at least post the mid-1980s.
  • The lowest inflation in Indian history occurred during 1999-2005, averaged only 3.9 per cent.
  • The average median rate among EM targetters during 2000-04 was 4 per cent, and among the non-targeting countries was 3.8 per cent.

Did fiscal deficit play role in inflation targeting

  • In 2003, India passed the FRBM act to control fiscal deficits and inflation.
  • There is precious little evidence, either domestically or internationally, about fiscal deficits affecting inflation.
  • For three consecutive years preceding the FRBM announcement, the consolidated Centre plus state deficits registered 10.9 per cent(in 2001), 10.4 and 10.9 per cent.
  • For the seven-year 1999-2005 period, consolidated fiscal deficits averaged 9.4 per cent of GDP.
  • Yet, that these years represented the golden period of Indian inflation — without FRBM and without IT.

Cost of inflation targeting in India

  • There are also costs to inflation targeting in India.
  • It led to higher real policy rates, in the mistaken belief that high policy rates affect the price of food, oil, or anything else.
  • But high real rates affect economic growth, by affecting the cost of domestic capital in this ultra-competitive world.
  • It is very likely not a coincidence that potential GDP growth, as acknowledged by RBI, was reached just before the MPC took over decision making in September 2016. 
  •  Since then there was a steady increase in real policy rates, and a steady decline in GDP growth.

Consider the question “How far has the inflation targeting mechanism been successful in India? Give reasons in support of your argument.” 


So, in the inflation targeting mechanism has not been successful in containing the inflation though there had a cost associated with it which we paid in the form of growth.

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