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Why Modi govt has done well to maintain continuity in inflation targeting framework

Many experts argued against retaining 4% plus-minus 2% target, while some wanted to scrap the framework altogether. But it provides stability, can help growth.

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The Narendra Modi government has decided to retain India’s inflation target at 4 per cent with a band of 2 per cent on either side for another five-year period, ending March 2026. This is a welcome decision.

In a previous column, we argued that changing the inflation target at this time could make the task of managing inflation expectations difficult.

In the current uncertain economic scenario, retaining the inflation target provides stability and helps the Reserve Bank of India’s Monetary Policy Committee focus on anchoring inflation expectations, while also balancing the objective of supporting growth.

Also read: Inflation targeting has worked for India, it is one of Modi govt’s defining achievements

Arguments against and for the current band

India adopted a flexible inflation targeting framework in 2016. The RBI Act, 1934, amended through the Finance Act of 2016, established a modern monetary policy framework with a clear objective of achieving price stability while keeping in mind the objective of growth. A six-member MPC, with three internal and three external members, was set up to determine the policy rate to achieve the inflation target. The Consumer Price Index-based inflation target was set by the government at 4 per cent, with a tolerance band of plus/minus 2 per cent for the period from August 2016 to March 2021.

One of the sections of the amended law requires that the rate of inflation to be targeted needs to be reviewed every five years. In March 2021, the central government along with the RBI was required to review the target.

In recent months, there has been a debate about revising the inflation target to allow the central bank greater leeway to cut interest rates and focus on growth in the pandemic-struck economy. In addition to revising the target, many commentators have suggested modifying the inflation targeting framework. There have been calls to abandon it.

The Economic Survey argued for changing the inflation metric from headline inflation to core inflation, and thus excluding food and fuel prices which are transitory and mainly supply side factors that monetary policy cannot influence.

However, the RBI has, through various publications, argued for retaining the inflation target at 4 per cent with a 2 per cent band. The RBI’s report on currency and finance argued that the current target band provides flexibility without undermining the discipline of the inflation target.

Tinkering with the inflation target could make the task of managing inflation expectations harder. Inflation expectations, while below the pre-inflation targeting regime levels, have been significantly higher than actual inflation. To anchor inflation expectations firmly, it is important to retain the inflation target at 4 per cent. Moreover, the 4 per cent target is also seen to be in alignment with trend inflation, which has fallen since 2015 and is around 4-4.2 per cent.

On the tolerance band of 2 per cent, the report argues that an upper tolerance limit of above 6 per cent would be counter-productive as it would hamper growth, while the lower mark of 2 per cent is also appropriate as any attempt to bring down inflation below 2 per cent would disincentivise production — firms would not be able to pass on increased input costs to final consumer.

Also read: Higher inflation doesn’t mean RBI’s Monetary Policy Committee should increase interest rates

No trade-off between growth and inflation

Those who are in favour of dismantling the inflation targeting framework altogether argue that since it was introduced, the RBI has not cut rates easily, and as a result, growth has suffered.

The critics argue that higher inflation should be tolerated to focus on growth. This is based on the premise that there is a trade-off between growth and inflation. However in the medium-to-long term, there is no trade-off between growth and inflation, so diluting focus on growth could undermine growth prospects.

Second, the inflation targeting that India has adopted gives enough flexibility to the RBI to focus on growth without losing sight of its inflation-control objective. Since the onset of the Covid-19 crisis and even before, the RBI has been focussing on growth — it has cut interest rates, maintained an accommodative stance, and made a commitment to maintain the stance as long as necessary to revive growth, even though inflation has been inching up due to supply side constraints.

In recent times, many countries have reviewed their inflation targeting frameworks to introduce flexibility to better manage the uncertain economic circumstances. The situation in advanced economies is that they are grappling with a low inflation and low interest rate scenario. Hence, they have changed their strategy to lift inflation.

For instance, the US Federal Reserve announced a shift to average inflation targeting. The implication of this shift is that the Fed would be willing to achieve inflation above 2 per cent for some time, following periods when inflation has been persistently running below the 2 per cent target. Japan has also introduced a similar strategy to allow inflation to rise above the 2 per cent target for some time to stimulate growth.

Emerging economies have also been reviewing their targets to anchor inflation expectations better while also introducing flexibility in their frameworks to respond to growth considerations. Thailand, for example, has made a shift from core inflation to headline inflation as the target, and also shifted from a ‘point target’ of 2.5 per cent with a band of plus-minus 1.5 per cent to a ‘range target’ of 1 to 3 per cent. The Thai central bank argues that introduction of a range target enhances flexibility in supporting growth more effectively.

Ila Patnaik is an economist and a professor at National Institute of Public Finance and Policy.

Radhika Pandey is a consultant at NIPFP.

Views are personal.

(Edited by Shreyas Sharma)

Also read: High growth, high volatility — what Indian economy can expect in the new financial year


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  1. Is inflation really under control? Every month, I find that my groceries and vegetables bills keep climbing up! We are just a family of three senior citizens. No luxury stuff for us.

  2. Look at daily edible items:
    (1) Toor dal increased from Rs.80/ kg (March 2020) to Rs.140/ kg.
    (2) Musturd Oil increased from Rs.105/ kg (March 2020) to Rs.150/ kg.
    Mrs. ILA PATNAIK should calculate herself the price rise/ inflation. It appears that she is not an economist. She is modinomist.

  3. The text books I read said inflation goes up when demand goes up. In a country reeling under covid-19, abject poverty, miserable employment prospects, demad is not there. No ticky, no laundry used to be chinese laundry women’s claim during thdepression era in the USA. No money, no demand. Inflation had nothing to do with the GOI in that sense.

  4. “Why Modi govt has done well to maintain continuity in inflation targeting framework”
    A surprise heading!!!
    A well presented piece where it is established that the primary aim of any economy is growth. Inflation targeting is one strategy to achieve growth – albeit it has to be handled deftly.
    The Indian economy may not be ready to adopt alternate available strategies for growth such as targeting currency exchange rates, unemployment rates (US),( For instance: There may be an economic trade-off between unemployment and inflation, as policies designed to reduce unemployment can create inflationary pressure, and vice versa) GDP growth etc
    Tail piece: Very little place for a full discussion. But goof effort to say it all

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