UPSC Relevance-Mains (GS III),Prelims-Monetary Policy Committee (MPC),CPI vs WPI,FRBM Act…
Why in News
India’s Flexible Inflation Targeting (FIT) framework — which mandates the RBI to maintain inflation at 4% ± 2% — is set to expire in March 2026. The framework is currently under review, and the RBI has released a major discussion paper seeking views on several components, including:
- Whether the target should be headline or core inflation
- What the optimal inflation level should be for India
- Whether the ±2% band should continue
This makes the debate crucial for India’s macroeconomic stability over the next decade.
Background
India adopted FIT in 2016, giving the RBI a clear mandate to target inflation and ensuring greater monetary policy autonomy.
This came after earlier reforms:
- Ending automatic monetisation (1994)
- FRBM Act (2003)
- Moving toward rules-based monetary policy
Since 2016, despite shocks like COVID-19, oil spikes, and global inflation, India has largely kept inflation within the 2–6% band. This is considered a major achievement for a still-evolving framework.
| Key Committees that Shaped India’s Inflation Framework 1. Chakravarty Committee (1985) First major committee to examine India’s monetary policy structure. Recommended 4% as an acceptable inflation rate, arguing that it helps reallocate resources toward growth sectors. Stressed controlling money supply to maintain price stability. 2. Urjit Patel Committee (2014) Proposed headline CPI inflation as the primary nominal anchor. Recommended the 4% inflation target with a ±2% band. Suggested setting up a Monetary Policy Committee (MPC) with transparency, accountability, and voting-based decisions. Laid the foundation for the 2016 FIT framework. |
Why Inflation Control Matters
Inflation control is not just an economic choice — it is a moral and distributional necessity.
- High inflation acts like a regressive tax, hurting poorer households disproportionately.
- It erodes savings, distorts investment decisions, and creates uncertainty for businesses.
- Historically, committees such as the Chakravarty Committee argued that around 4% inflation may be acceptable for India to facilitate resource allocation.
Examples:
- 2010–2013 saw double-digit inflation, which severely hurt rural purchasing power and pushed households into informal debt.
- During COVID-era supply disruptions, low-income households faced the biggest hit from food inflation.
Thus, inflation control remains the RBI’s central responsibility.
Headline vs Core: What Should India Target?
A recurring debate is whether India should target:
- Headline inflation (includes food & fuel),
or - Core inflation (removes food & fuel).
The article argues strongly for headline inflation because:
- The poor spend a higher share on food — ignoring food inflation makes the framework socially unjust.
- Food inflation is not only a supply issue. When monetary policy is loose, food inflation rises faster.
- India’s data shows second-round effects: when food prices rise, wages and input costs rise too → spilling into core inflation.
- Milton Friedman’s classic point: Without excess money supply, general prices cannot rise. Thus, excluding food inflation misses the link between money supply and broad inflation.
Example:The onion price spike episodes (2013 and 2019) showed that food inflation spilled over into wage costs and transportation, affecting overall inflation.
Conclusion:Monetary policy must include food inflation.
What is the Acceptable Level of Inflation?
The Phillips Curve once suggested a trade-off between inflation and growth. But decades of research (Friedman, Phelps) show:
- Only short-run trade-off exists
- No long-run trade-off once expectations adjust
India’s own data since 1991 (excluding COVID year) shows:
- A non-linear relationship between inflation and growth
- The “turning point” is around 3.98%
This means:Inflation near 4% maximises growth.
Beyond 4%, higher inflation reduces growth.
Forward-looking simulations for 2026–2031 also indicate acceptable inflation below 4%, though fiscal pressures must be accounted for.
Conclusion:There is no strong case for raising the target above 4%.
Inflation Band: Should ±2% Continue?
The current band — 2% to 6% — has given enough flexibility to the RBI. But two major concerns arise:
1. How long can inflation stay near 6%?
If inflation remains close to 6% for extended periods, the spirit of the framework collapses.
Data shows:Beyond 6%, growth declines sharply.
Thus, staying near the upper limit for long is dangerous.
2. Fiscal-monetary coordination matters
India’s inflation history shows:
- 1970s–80s high inflation was driven largely by monetisation of fiscal deficits.
- Early 1990s reforms abolished automatic monetisation.
- FRBM Act further tightened fiscal discipline.
- FIT naturally followed.
Key message: FRBM and FIT must operate together.
If one slips, the other collapses — risking macro instability.
Example:The fiscal slippages of 2009–11, combined with loose monetary conditions, pushed inflation to double digits and weakened growth.
Key Challenges
- Managing food price volatility in a country where food has a large CPI weight
- Ensuring fiscal discipline (FRBM) while maintaining monetary credibility (FIT)
- Preventing inflation expectations from becoming unanchored
- External risks: global commodity price shocks, geopolitics, supply disruptions
- Maintaining growth momentum without tolerating high inflation
Way Forward
- Retain the 4% target as it balances growth and stability.
- Keep the ±2% band, but add rules to prevent staying near 6% for long.
- Target headline inflation, not core.
- Strengthen fiscal discipline under FRBM to avoid inflationary pressures.
- Improve food supply chain management to reduce price shocks.
- Enhance communication by RBI to anchor market expectations.
- Build better forecasting models for food prices and second-round effects.
Conclusion
India’s Flexible Inflation Targeting framework has stabilised inflation during a turbulent decade. Evidence strongly supports retaining the 4% target, including food inflation in monetary policy, and maintaining the current ±2% band. But this must go hand-in-hand with fiscal discipline. Together, FRBM and FIT form the twin pillars of India’s macroeconomic stability.
UPSC Prelims Practice Questions
Q1.With reference to India’s Flexible Inflation Targeting (FIT) framework, consider the following statements:
- The current inflation target of 4% ± 2% was adopted based on the recommendations of the Urjit Patel Committee.
- The inflation target is notified under the Reserve Bank of India Act, 1934.
- The inflation band prescribes how long the RBI can remain above the upper limit before it is considered a failure.
Which of the statements given above is/are correct?
(A) 1 and 2 only
(B) 2 only
(C) 1 and 3 only
(D) 1, 2 and 3
Q2.Consider the following:
- High inflation acts as a regressive consumption tax.
- High and volatile inflation can misdirect investments.
- The Chakravarty Committee recommended the “acceptable” level of inflation near 4%.
How many of the statements above are correct?
(A) Only one
(B) Only two
(C) All three
(D) None
Q3.The concept of threshold inflation refers to:
(A) The maximum inflation rate that can be tolerated without affecting export competitiveness.
(B) A level of inflation beyond which further rise begins to hurt economic growth.
(C) The inflation level at which unemployment reaches its natural rate.
(D) The minimum inflation required to sustain aggregate demand in developing economies.
Q4.Which of the following reforms helped reduce fiscal dominance over monetary policy in India?
- Ending automatic monetisation of deficits
- Abolition of ad hoc treasury bills
- Enactment of the FRBM Act
- Introduction of the Goods and Services Tax (GST)
Select the correct answer using the code below:
(A) 1, 2 and 3 only
(B) 2, 3 and 4 only
(C) 1 and 4 only
(D) 1, 2, 3 and 4
Q5.India’s inflation has remained largely range-bound since 2016 primarily because of:
(A) Adoption of full capital account convertibility
(B) Flexible Inflation Targeting with institutional autonomy to the RBI
(C) RBI shifting exclusively to a fixed exchange rate regime
(D) Complete elimination of food and fuel prices from CPI calculation
UPSC Mains practice Question
Q. “As India reviews its Flexible Inflation Targeting (FIT) framework for the post-2026 period, maintaining price stability while enabling growth remains a delicate balancing act.”
Discuss the key issues involved in revisiting the inflation target, the acceptable level of inflation for India, and the appropriate width of the inflation band. Also evaluate how fiscal discipline and earlier committee recommendations shape India’s inflation-management framework. (250 words)