10 years of inflation targeting: How elephant was driven away to the jungle

India's inflation-targeting framework has anchored price expectations, but economists see scope to refine its mandate

The overhang of the liquidity stimulus of the Covid period was still there when Russia invaded Ukraine in late February 2022. The conflict and its resultant supply-side issues caused domestic inflation to surge to 7.8 per cent in April 2022. Against this backdrop, an off-cycle meeting of the Monetary Policy Committee (MPC) was called, and the policy repo rate was increased by 40 basis points (bps) to 4.4 per cent — the first hike since the once-in-a-century pandemic. This was followed by another 50-bp hike in June. The terminal rate in the cycle was 6.5 per cent, and the MPC, headed by then Reserve Bank of India (RBI) Governor Shaktikanta Das, did not cut rates until the end of his tenure in December 2024. Das was the second-longest-serving governor in the RBI’s 91-year history. “The elephant has now gone out for a walk,” Das famously commented in April 2024 to describe how the massive inflation monster was finally tamed. Later, Das pivoted the metaphor to a horse, saying it had been successfully brought back to the stable but needed close monitoring so that it did not bolt again. The flexible inflation-targeting (FIT) framework, which came into effect in October 2016, is one of the key reasons why inflation remained under control for most of the time, except in the post-Covid era. Under the Reserve Bank of India Act, 1934 (as amended in 2016), the RBI is entrusted with the responsibility of conducting monetary policy in India, with the primary objective of maintaining price stability while keeping in mind the objective of growth. “Since implementation, Consumer Price Index (CPI) inflation has averaged 4.6 per cent, as against 7.5 per cent in the (four) years before implementation,” said Sameer Narang, chief economist, ICICI Bank. “The lower inflation outcome is visible in both food (4.5 per cent) and core (4.8 per cent) inflation. Notably, food inflation has seen a bigger decline during the FIT period, which is due to effective supply management by the government,” Narang said. While New Zealand was the first country to adopt inflation targeting in 1990, such a framework has increasingly gained significance globally, with 48 countries, comprising 14 advanced economies and 34 emerging and  developing economies, having inflation targeting as their monetary policy framework. “With price stability at the core, FIT has helped anchor inflation expectations and establish central bank credibility and transparency during a period marked by policy changes, the pandemic and elevated geopolitical issues,” said Sreejith Balasubramanian, senior economist, fixed income, Bandhan AMC. No major country that has adopted FIT has ever abandoned it. The framework has been fine-tuned from time to time in line with domestic considerations to make it more effective. In India, the mandate for the RBI is to target 4 per cent inflation, with a band of +/- 2 per cent around it. The central government, in consultation with the RBI, determines the inflation target in terms of CPI once every five years and notifies it in the Official Gazette. The target is reviewed every five years.  

The target has been reviewed twice and kept unchanged, with the current phase coming into effect from April 1, 2026. Yet, there could be scope in the future to sharpen the framework.

 “FIT must continue to recognise the significance of price stability for sustainable growth and macroeconomic stability. The ±2 per cent band around the 4 per cent headline CPI target could be reviewed with time and experience with FIT, Balasubramanian said.Some economists suggested including growth as an explicit mandate. “Though we have a single mandate, the only addition I would like to add would be a clear mandate for growth, which is not there. For example, the Fed has an inflation mandate and a maximum employment mandate. Since we are an emerging market, we should also have a clear mandate for growth,” said Gaura Sen Gupta, chief economist, IDFC First Bank. “Though effectively the RBI remains growth supportive. For example, when you had the Covid shock, they looked through that shock even though inflation breached the 6 per cent band. But the RBI looked through that shock because it is temporary. So, they made that judgment call and they remain growth supportive. But I think the framework requires an addition for growth,” Sen Gupta added. As the six-member monetary policy committee to set to embark on another rate hike cycle next week — as widely expected — the efficacy of the FIT will be tested yet again, which may lead to tweaks in the framework. But one thing for sure: there is no going back. 

India’s first decade of flexible inflation targeting

 India adopted a flexible inflation targeting framework in October 2016, with the Reserve Bank of India (RBI) and the Centre setting the consumer inflation target at 4 per cent, a tolerance band of +/- 2 per cent, and a six-member rate-setting panel, the Monetary Policy Committee (MPC), chaired by the RBI governor. At its maiden meet under Urjit Patel in October 2016, the MPC cut the repo rate by 25 basis points (bps) to 6.25 per cent. Shaktikanta Das’ first MPC meet in February 2019 also yielded a 25 bps rate cut. Similarly, the present Governor Sanjay Malhotra’s first MPC meet in February 2025 also delivered a 25 bps rate cut. A look at how the interest rate and retail inflation have played out under this framework.