RBI floats discussion paper to review inflation targeting framework
Mumbai, Aug 21, 2025
The Reserve Bank of India (RBI) has floated a discussion paper ahead of the second review of its inflation targeting framework (FIT), due by March 2026, to examine whether to target core or headline inflation.
The review will also assess whether the 4 per cent inflation target remains optimal for balancing growth with stability in India’s rapidly growing, large emerging economy. Additionally, the paper will consider whether RBI should target a fixed number or a band.
The paper will further examine if the current tolerance band, set at +/- 2 per cent, should be narrowed or widened. Under the Act, the RBI is mandated to maintain a Consumer Price Index (CPI) inflation target of 4.0 per cent with a tolerance band around it.
The FIT framework, in place since October 2016, is reviewed every five years. In the first review conducted in March 2021, the 4 per cent target was retained for the subsequent five years, until March 2026.
“With price stability being a shared responsibility between the government and the central bank, effective monetary-fiscal coordination, through supply-side interventions and monetary tightening to prevent second-round effects, ensured the success of FIT,” the discussion paper stated.
The paper observed that the experience with the FIT framework, introduced in 2016 and first reviewed in 2021, has broadly been positive. “On the whole, the inflation performance over the nine years of FIT shows a hump-shaped performance, with the first three years and last three years aligning with the target,” it noted.
On whether to target headline or core inflation, the report said that headline inflation is preferred globally as a more representative measure of overall price conditions. With the high share of food in the consumption basket, food inflation pressures cannot be ignored in India.
The paper cited cross-country data showing that almost all inflation-targeting countries have chosen headline CPI as their target, irrespective of their inflation target level or stage of development. Currently, Uganda is the only country targeting core inflation.
Regarding the argument to eliminate food from the target, the discussion paper quoted former RBI Governor Shaktikanta Das: “Not having a target would make no sense to the average citizen, as it is the headline inflation that the common person understands and should remain that way.”
On the argument that the current CPI base (2011-12) is outdated, and that the share of food would decline once the base is updated, the paper stated that food continues to dominate Indian households’ consumption, as corroborated by the latest Survey of Household Consumption Expenditure 2023-24. The survey shows that 90 per cent of the lowest fractile rural households and 50 per cent of the lowest fractile urban households spend over 50 per cent of their monthly consumption on food and energy.
On whether the 4 per cent target should remain, the paper pointed to empirical evidence suggesting that in India, 4 per cent is the optimal inflation rate at which macroeconomic conditions remain stable with zero output gap.
There was an argument to raise the target to 6 per cent, which was considered optimal for India. However, the paper cautioned that increasing the target now, amid geopolitical uncertainty and geo-economic fragmentation, could be perceived by global investors as a dilution of the FIT framework, undermining policy credibility.
“It could erode the gains in policy and institutional credibility achieved through fiscal responsibility and external stability,” the paper warned.
On reviewing the tolerance band, the report noted that the current band offers flexibility to account for shocks in food, energy, and other volatile components, as well as any forecasting and measurement errors.
The report argued that replacing the target with a band could be seen as diluting the framework, eroding policy credibility, and weakening the commitment to price stability by both domestic and international investors.
RBI said that releasing a discussion paper aligns with global practice. Such a paper was not released for public feedback during the first review. Feedback on this paper must be submitted by 18 September 2025.
[The Business Standard]
