Inflation target should align with advanced economy average of 2%: Patra

Michael Debabrata Patra is the longest serving member of monetary policy committee, first as an ex-officio member nominated by the central bank board and then as the deputy governor in-charge of monetary policy. He was also the member secretary of the Urjit Patel committee which proposed the inflation targeting framework.

 

In an email interview to Subrata Panda, the former deputy governor says flexible inflation target regime is essentially about ensuring that the economy grows at its full potential.

  

Former RBI Deputy Governor Michael Debabrata Patra reflects on the decade of flexible inflation targeting, its contribution to price stability and economic growth, and the lessons from the 2022 inflation breach. He also discusses the need for policy flexibility, the importance of continuity among external MPC members and the factors that should guide India’s inflation target in an email interview with Subrata Panda. Edited Excerpts:

 

Ten years on, what is the strongest evidence that FIT itself—rather than favourable supply shocks or other macro factors—improved India’s inflation performance? 

 

The strongest evidence that FIT has done well is the evidence itself. Shocks, whether favourable or adverse, are by definition short-lived. After the initial impact, the target variable such as inflation should revert to its pre-shock state if the regime or framework itself is stable and inflation expectations are intrinsically anchored. If not, inflation will tend to drift away from the target. Ten years is a long enough period for shocks to dissipate and for making an assessment if the target variable has been mean reverting or not. Over the first five years of FIT, including the years of the commodity cycle downswing and the year of the pandemic, headline inflation averaged 4.5 percent. Over the next five years which included the war in Ukraine, the conflict in the Middle East and the war in west Asia, which are not mean reverting shocks at all, it averaged 4.9 per cent. That is, inflation was aligned with the 4 per cent handle in both quinquennial periods. Obviously, it is something other than favourable factors or good luck that is holding inflation aligned with the target. In my view, it is FIT.

 

You studied MPCs before India adopted one. After a decade on India's MPC, what did you get right, and what did you get wrong?

 

If I were to pinpoint one aspect on both sides in the interest of time and space, I believe that the flexibility that we built into the framework was a great achievement. By that I don’t mean just the flexibility about aligning inflation with the target, such as the three consecutive quarters criterion, or the average rather than the point criterion. I also mean the flexibility in assigning a higher weight to the secondary objective, growth, even when inflation was breaching the upper tolerance band during the pandemic. The pandemic management strategy did not just minimise the losses of lives and livelihoods. It also minimised the welfare losses of temporarily tolerating the deviation of inflation from the target. One aspect which I believe we didn’t get right is to allow the external members to depart all at the same time. By doing so, the continuity of experience, the handing over of the baton, that is available to the internal side of the MPC is lost on the external side.

 

Has dissent made the MPC better, or has the committee become more predictable and convergent over time? Do you think internal members should disagree more often?

 

The eventual decision of the MPC that is placed in the public domain is not as mellifluous and emollient as it might seem to the unsuspecting eye. A lot of parleys, challenges to each other’s viewpoints, debates on forecasts, and divergent discussions on macroeconomic and financial conditions go into each final outcome. From my experience, the liveliest differences of opinions are among internal members who start work several weeks ahead of the MPC meeting. Each internal member has to argue against the other with facts and updates that are being marshalled in real time. A close reality check is what the rest of the central banking community is doing, again virtually in real time. And there is always the sobering discipline of the markets which impinges on internal members a great deal as it is also part of their work. It is to the credit of and reflecting the dignity with which the MPC conducts itself that, once the decision is reached, there is no washing of the linen in public.

 

The 2025 RBI discussion paper on the monetary policy framework provides evidence on a wide diversity of opinion from the significant differences in the voting pattern on the policy rate and stance across members over time. The paper shows that over its tenure, the MPC took more split decisions than unanimous calls, and even when members agreed, their arguments and rationale often differed. The lack of unanimity on policy (repo) rate decisions exhibits individual MPC members’ freedom to assign relative importance to inflation and growth objectives while voting. The MPC has shown maximum dissent while keeping the repo rate unchanged (pause), followed by rate cuts – clearly a hawkish MPC!

 

How much can monetary policy realistically achieve when India's biggest inflation shocks are food- and supply-driven?

 

First of all, it is important to recognise that, irrespective of the type of shock, monetary policy can bring inflation to the target. In fact, when monetary policy has been deployed, it does not distinguish between types of shocks. It goes straight for the kill. That is why it is often termed as a blunt instrument. Second, it is for this reason that when the shock is sectoral, like a food or fuel shock, the first impact of the shock is absorbed by monetary policy. This creates time for other more nuanced and targeted instruments like supply management to be used to adjust sectoral imbalances. If, however, sectoral imbalances become long lasting and generalised, they get reflected in second order effects like increases in wages, transport costs, rents, core prices. Then the case for activating money policy is explicit, even at the cost of some sacrifice of growth.

 

Is 4% still the right inflation target for India? Are inflation expectations genuinely anchored at 4%?

 

There are several factors that need to be taken into account while deciding on the appropriate inflation target. One key factor is the time varying trend rate of inflation. If the target is set above this trend, monetary policy can become overly restrictive and depress growth. If the target is set below the trend, monetary policy will be unduly accommodative and produce bursts of high inflation. The time varying trend inflation rate is not directly observable. It has to be assessed from the structural characteristics of the economy. This has to be a continuous assessment as economies are slow to change structurally but they do change. To give an example, will the artificial intelligence (AI) revolution lower or raise the time varying trend rate of inflation? If AI is associated with economy wide productivity gains, it is possible that the trend rate of inflation will decline and so will the target rate of inflation. On the other hand, the massive investment boom associated with AI and the concentration of power in a few corporations can cause the time varying trend rate of inflation to be higher than now. If so, the target for inflation must be raised. It is important to bear in mind that if India has to become an advanced economy one day, its inflation target must align with the advanced economy average, which is 2 per cent today.

  

What did the 2022 breach of the 6% upper tolerance band for three consecutive quarters teach the MPC about the limits of inflation targeting?

 

Rather than just the MPC, the lessons were global. First, the pandemic created supply and logistics bottlenecks that pushed up inflation. By 2022, these bottlenecks unwound in what is called a bull-whip effect but it was overwhelmed by a surge in revenge spending as people emerged from lockdowns and isolation. Most central banks were blindsided in believing that supply bottlenecks were continuing to put upside pressures on inflation, but in reality excess demand had taken over as the inflation driver.

 

That is the problem with supply shocks. They can lull you into complacency.

 

The second lesson we all learned is that it is better to be preemptive and frontload monetary policy action if inflation appears to be digging in. It is the risk minimisation strategy.

 

Third, there will always be shrill, discordant voices crying out that monetary policy has been unduly restrictive and has killed growth. To monetary policy makers I will say, never back down. Always believe that it is by price stability that the foundation of sustained high growth is laid. By being anti-inflationary, monetary policy makes the biggest contribution to growth. Look at the post 2022 experience: growth has not clocked less than 7 percent in any year. In fact, it is within striking distance of averaging 8 percent.  

 

RBI has started providing core inflation forecasts. Do you think this clarity was much needed for the market?

 

The target is defined in terms of headline inflation. Hence, the public presentations of analyses are always in terms of the headline. But the analyses themselves are sectoral, spatial, regional and granular. Look at the monetary policy report. It is replete with assessments of item wise behaviour of the CPI. Some times, these analytical nuances creep into the MPC’s resolutions when a particular point of emphasis relating to the shifting drivers of inflation is sought to be conveyed to the public. The fact that the RBI is now emboldened to put out forecasts of core inflation is a testimony to the versatility of the analyses. The issue is communication. While it is easy to convey the message of the core inflation forecast to analysts and economists that inform market expectations, it is difficult to explain to the lay public that has to deal with inflation in its day to day existence as to why the authority vested with the responsibility of inflation control leaves out a greater part of it in its forecast. The question will inevitably be asked: who is responsible for the large part of inflation that has been left behind?  

 

Has FIT delivered a net growth benefit?

 

My answer would be an unambiguous yes. There is a persisting misconception that FIT is single-mindedly about inflation. Nothing can be farther from the reality. FIT is essentially about ensuring that the economy grows at its full potential. If growth rises above potential, there will be overheating of the economy and this can derail growth itself. How do we know that the economy is overheating? After all, the economy’s potential is not observable. It is inflation rising relative to the target over some time that is the symptom. By bringing inflation back to target, the growth rate is re-aligned with its potential. Analogously, when the economy is performing below potential, this will show up in an inordinate slowdown in the rate of price change or even in deflation. By being expansionary and supporting the economy, deflation is addressed and the economy returns to potential.

 

In the aftermath of the pandemic, that is from 2021-22 to 2025-26, the Indian economy has averaged real growth of 7.8 percent. In fact, overlaid on this trend is the recent quarterly path - over the period July-September 2025 to April-June 2026, real growth has averaged above 8 percent. In this period, FIT has survived COVID-19, the war in Ukraine, a synchronised tightening of monetary policy worldwide, the conflict in the Middle East, tariff tantrums, geo-economic fragmentation, and the war in west Asia. It has clearly stood the test of time.