Key Facts

  • Target: 4% retail inflation with a tolerance band of +/- 2% (i.e., 2%‑6%).
  • Period: 1 April 2026 to 31 March 2031 (5‑year extension).
  • Framework: Flexible Inflation Targeting (FIT) adopted in 2016, now extended for the second time since 2021.
  • Legal Backing: Section 45‑ZA of the RBI Act, 1934 mandates price‑stability as the primary objective of monetary policy, keeping growth in mind.
  • Anchor Index: Headline Consumer Price Index (CPI) with base year 2024.
  • Monetary Policy Committee (MPC): Meets at least four times a year to decide the repo rate.
  • Accountability: RBI must submit a report to the Government if inflation stays outside the 2‑6% band for three consecutive quarters.
  • Performance: Average inflation under FIT (2016‑2025) fell to 4.9%, down from 6.8% in the pre‑FIT period.

Background and Context

  • FIT Concept: Unlike strict inflation targeting, FIT allows the central bank to tolerate short‑term deviations to avoid harming growth and employment.
  • Global Precedent: First adopted by New Zealand in 1990; India shifted to FIT in 2016 following the Urjit Patel Committee recommendations.
  • Historical Trend: The first three years (2016‑2018) and the last three years (2023‑2025) of the FIT period stayed close to the 4% target, while the middle three years saw higher inflation due to COVID‑19 and the Russia‑Ukraine conflict.

Significance for India / Governance / Policy

  • Macroeconomic Stability: A clear, long‑term target anchors inflation expectations, aiding investment and fiscal planning.
  • Policy Credibility: Extending the target reinforces RBI’s independence and the government's commitment to price stability.
  • Growth Consideration: The flexible band permits the RBI to balance inflation control with growth support, especially during supply‑side shocks.
  • Fiscal‑Monetary Coordination: A stable inflation environment reduces the cost of borrowing for the government and private sector.

Related Constitutional / Legal Provisions

  • Section 45‑ZA, RBI Act, 1934: Mandates the primary objective of monetary policy – price stability with a view to growth.
  • Government‑RBI Consultation: The target is set jointly every five years, reflecting cooperative federalism in economic governance.

Instruments Used Under FIT

  • Repo Rate: Main policy rate influencing borrowing costs.
  • Cash Reserve Ratio (CRR) & Statutory Liquidity Ratio (SLR): Adjust liquidity in the banking system.
  • Open Market Operations (OMO): Buying/selling government securities to manage money supply.
  • MPC Stances: Accommodative, Neutral, Hawkish – communicated to guide market expectations.

Frequently Asked Questions (FAQs)

  1. Current inflation target? 4% with +/-2% band (2%‑6%).
  2. Statutory basis? Section 45‑ZA of the RBI Act, 1934.
  3. Consequence of missing the band for 3 quarters? RBI must submit a detailed report to the Government.
  4. How does MPC influence inflation? By adjusting the repo rate and using other monetary tools.

UPSC Relevance

  • Prelims: Factual data – target level, legal provision, MPC composition.
  • Mains: Analytical questions on the impact of FIT on growth, fiscal stability, and policy credibility.
  • Essay: Discussion on the merits and challenges of flexible inflation targeting in a developing economy.