RBI’s Discussion Paper on Flexible Inflation Targeting (FIT)

RBI has released a discussion paper to review the Flexible Inflation Targeting (FIT) framework as the current 4% CPI target (with a 2–6% band) ends in March 2026. RBI warns that raising the target could weaken policy credibility and undo past gains.

Why Retain the 4% Target?

• Global Credibility & Investor Confidence
  • A higher target may be seen as accepting higher inflation, hurting India’s reputation.
  • S&P Global’s upgrade to BBB cited strong inflation management as key.
• Institutional Strength
  • FIT strengthened Monetary Policy Committee (MPC) credibility and fiscal discipline.
• Domestic Success
  • CPI inflation mostly stayed within 2–6% since 2016.
  • July 2025 CPI at 1.55% shows effective price stability.
• External Stability
  • Low inflation protects the rupee, supports capital inflows, and maintains trade competitiveness.

Headline vs. Core Inflation

• Headline CPI: Includes all items (food, fuel, housing, etc.).
• Core CPI: Excludes food & fuel (more stable but less relevant for households).
• Arguments for Core Targeting (2023–24 Survey):
  • Food inflation is supply-driven and beyond RBI’s control.

RBI’s Stand:

• Food shocks spill over to wages and prices, impacting core inflation over time.
• Global Practice: Most countries target headline CPI (Uganda is the exception).
• India’s Reality: With food ~50% of CPI, excluding it would ignore what matters most to people.

Flexible Inflation Targeting (FIT)

• A monetary policy framework where the central bank sets a specific inflation target but retains the flexibility to consider growth, employment, and financial stability.
• In India: Adopted in 2016 under an amendment to the RBI Act, 1934.

Benefits of FIT So Far

• Anchored Expectations: People and businesses trust RBI’s 4% target.
• Improved Sovereign Ratings: Credible policy boosts ratings like S&P’s upgrade.
• External Stability: Strengthened rupee, steady capital inflows.
• Investor Confidence: Predictable inflation lowers risk, boosts FDI/FDI.
• Shock Resilience: Prevented runaway inflation despite global turmoil.

IE