RBI comfortable with inflation target range for five years

This concept of inflation targeting emanates from the FIT framework which was first evolved in 2016.

March 03, 2021 11:24 IST | India Infoline News Service
There have been persistent questions on whether RBI should modify its range for inflation targeting. Inflation targeting is a strategy that Indian officially embarked on in 2016 which entails defining a range within which CPI inflation should ideally persist. However, the latest RBI Report on Currency and Finance (RCF) for the financial year 2020-21 has ruled out any shift in the inflation targeting range for the next 5 years.

According to the report, "The current numerical framework for defining price stability as an inflation target of 4% with a (+/-2%) tolerance band is appropriate for the next five years”. RBI has affirmed that between FY21 and FY26, RBI would be comfortable with a median inflation target of 4% with worst-case inflation of 6% and a best-case inflation of 2%.

A quick word on the FIT framework

This concept of inflation targeting emanates from the FIT framework which was first evolved in 2016. The idea was to provide a longer-term perspective to monetary policy by setting an inflation range instead of an inflation point. Since CPI inflation is largely driven by food prices which are subject to the vagaries of monsoon, targeting an inflation point becomes practically complicated. That is why the FIT framework targets an inflation range for the economy. For the sake of continuity and greater stability, this framework is reviewed and fixed for a period of 5 years.

India officially adopted the FIT (Flexible Inflation Targeting) framework in 2016. Back then, RBI had set the inflation at a median level of 4% with a broad range of (+/- 2%). The inflation targeting is done for a period of 5 years and the first FIT time frame was to get over on 31 Mar 2021. During this period, a combination of the pandemic and an economic slowdown had resulted in expectations that the range could change this time around.

However, on 26 February the RBI clarified that the current inflation target of 4 % with a +/-2 % tolerance band would be appropriate for the next five years up to March 2026. RBI relied on data from March 2016 till March 2020 excluding the COVID period data to avoid distortions in the inflation target framework. The bottom line is that the current inflation target range of (+2% to +6%) inflation will continue. Here is why.

Current inflation target has served its purpose

In the last one year, there have been debates on whether the RBI should conduct monetary policy to boost growth or to ensure price stability. In the minutes of the February 2021 monetary policy, the RBI governor clarified in no uncertain terms that the primary role of RBI will continue to focus on price stability. He underlined that the growth shift visible in the last one year was a response to COVID-19 stress. Apparently, once the COVID stress recedes, RBI will get back to its primary goal of maintaining price stability.

Mao Ze Dong once famously said, “A cat is a good cat as long as it catches mice”. The same applies to the RBI FIT framework. The RBI Report on Currency and Finance noted that the trend inflation had fallen from above 9% before the FIT was implemented to an average range of 3.8-4.3 % after the FIT framework was implemented. When the framework was working fine and doing its job, there was no urgency to make any changes.

If inflation is falling, why not narrow the FIT band?

Data Source: MOSPI

Demands to broaden the band were rejected in the interest of price discipline. But there were also demands to narrow the band from 4% to a finer range of 2.5% to 3%. As the inflation chart shows, CPI inflation has shown a tendency to taper and even the spike in the last one year was due to supply chain constraints created by the COVID-19.

There are two possible reasons for retaining the FIT range despite lower inflation. Firstly, the real picture of inflation under normal economic conditions will be evident post-COVID. That still needs time and RBI is playing safe. Secondly, there are two aspects of the CPI inflation basket which cannot be influenced by the RBI in the short term.

Core inflation has remained sticky at above 5.5% despite the fall in headline inflation. These are structural challenges, so any disruption in food supply could have an oversized impact on inflation. Also, crude oil has a primary and secondary impact on CPI inflation and that is out of India’s control. Hence RBI has played safe by sticking to its erstwhile inflation range.

The good news is that the RBI is not willing to compromise on price stability from a policy perspective. That augurs well as India gradually moves towards making the Indian rupee convertible on the current and capital account. That will take more time!

OPEN A DEMAT ACCOUNT & Get FREE Benefits worth 10,000

FREE Benefits worth 10,000



The average score for Prestige Estates Projects Limited stands at 4 against 6, three months back.

Prestige Estates Projects Limited is engaged in the business of real estate development. The Company’s principal products/services include Development and construction



Open ZERO Brokerage Demat Account

  • 0

    Delivery Brokerage for Lifetime

  • 20

    Per order for Intraday, F&O, Currency & Commodity