RBI floats discussion paper to review inflation targeting framework

RBI has launched a discussion paper to review its inflation targeting framework, focusing on the core vs headline inflation debate, the 4% target, and tolerance band before next review in March 2026

Ahead of the second review of the country’s flexible inflation targeting framework (FIT) due in March 2026, the Reserve Bank of India (RBI) on Thursday floated a discussion paper seeking feedback on four critical questions, including the appropriateness of persisting with the 4 per cent goal and if the focus should be on headline or core inflation. 

The paper also seeks inputs from stakeholders on whether the RBI should target a tolerance band or a specific number, and if the tolerance band of +-2 per cent should be narrowed or widened. 

The FIT framework, which is in place since October 2016, is to be reviewed every five years. In the first review conducted in March 2021, the target was retained for the subsequent five years till March 2026. At present, the RBI Act mandates the central bank to maintain a Consumer Price Index (CPI) inflation target of 4.0 per cent with a tolerance band of +/- 2 per cent around it.

 

The discussion paper put up for review the question of whether the 4 per cent inflation target continues to remain optimal for balancing growth with stability in a fast growing, large emerging economy like India. 

The paper observed that the experience of the FIT framework, introduced in the year 2016 and first reviewed in 2021 has broadly performed well. “On the whole, assessing the inflation performance over the nine years of FIT enunciates a hump-shaped performance with the first three years and last three years remaining aligned to the target,” it said. 

“With price stability being a shared responsibility between the government and the central bank, effective monetary-fiscal coordination in the form of supply side interventions along with monetary tightening to prevent second round effects ensured the success of FIT,” the discussion paper said.

 

On the debate on whether to target headline or core inflation, the report said headline inflation is favoured worldwide as a more representative measure of the overall price conditions, and with a high share of food in the consumption basket, food inflation pressures cannot be ignored in India.

 

The paper cited cross-country data which showed that almost all inflation targeting countries have chosen headline CPI as the target, irrespective of their inflation target level and stage of development. Currently, Uganda is the only country that targets core inflation.

 

On the argument of eliminating food from the target, the discussion paper quoted former RBI Governor Shaktikanta Das, who had said that “not having a target; it will 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 the share of food would decline considerably once the CPI base is revised to a more recent year, it said the continued dominance of food in Indian households’ consumption basket is corroborated by the latest Survey of Household Consumption Expenditure 2023-24.  The Survey indicates that 90 per cent of the lowest fractile rural households and 50 per cent of the lowest fractile urban households spend more than 50 per cent of their monthly consumption on food and energy.

 

On whether 4 per cent should remain as the FIT goal, the paper said empirical evidence suggested that in the Indian context, 4 per cent is the desirable rate of inflation at which macroeconomic conditions remain optimal with zero output gap.

 

There was an argument in favour of raising the target to 6 per cent as it was considered optimal for India. However, the paper said, raising the target at this stage – when the global economy is confronted with geopolitical uncertainty and geo-economic fragmentation – can be interpreted by global investors as a dilution of the inflation targeting framework thereby undermining policy credibility.

 

“It could erode the gains in policy and institutional credibility achieved through fiscal responsibility and external stability,” the paper cautioned.

 

On the review of the tolerance band, the report noted that the current tolerance band provides flexibility to account for shocks in food, energy and other volatile components along with any forecast and measurement errors.

 

The report said removing the target and replacing it with a band could also be construed as a dilution of the existing framework eroding policy credibility as it may be interpreted as weakening of the commitment to price stability by domestic economic agents and international investors.

 

The RBI said a discussion paper on the issue was in line with the global practice. Such a discussion paper was not put out in the public domain for feedback during the first review. Feedback on the RBI’s discussion paper has been sought from stakeholders by September 18, 2025.