Flexible Inflation-Targeting Framework

India’s flexible inflation-targeting framework seeks to keep headline retail inflation near a publicly announced target while allowing monetary policy some flexibility to address growth and temporary supply shocks. The prescribed target is 4 per cent CPI inflation, with a tolerance band of 2 percentage points on either side, meaning 2-6 per cent.

Statutory basis and target

Under Section 45ZA of the RBI Act, 1934, the Central Government, in consultation with the Reserve Bank of India, determines the inflation target once every five years. The target uses the year-on-year change in the Consumer Price Index, Combined, published by the National Statistical Office.

• The numerical target is 4 per cent, with an upper tolerance level of 6 per cent and a lower tolerance level of 2 per cent.
• The target and tolerance band were retained for the period from 1 April 2021 to 31 March 2026.

How flexibility operates

The tolerance band permits the Monetary Policy Committee to accommodate temporary price shocks rather than mechanically maintaining inflation at exactly 4 per cent at all times. Price stability remains the primary objective of monetary policy, while the objective of growth is kept in mind.

• Failure occurs when average inflation remains above 6 per cent or below 2 per cent for three consecutive quarters.
• On such failure, the RBI must report to the Central Government the reasons, proposed remedial actions and the estimated time for returning inflation to the target.