Inflation Targeting

Inflation is the rate of change in the prices of a given set of items. India bases its retail inflation metrics on the Consumer Price Index (CPI).
The index records changes in prices for a sample of family budget items that are representative of what consumers typically spend their household income on — food, fuel, housing, clothing, health, education, amusement and even paan, tobacco and intoxicants.
The measure is based on a weighted average. That is, some items in the index may get greater weightage depending on their priority in a typical family’s budget.
The CPI-based retail inflation is measured monthly and is published as a percentage value of change in the index from the corresponding year-earlier period.
Data for a certain month are released by the Ministry of Statistics and Programme Implementation with base year 2011-12.

The RBI’s explicit mandate is to conduct monetary policy. The primary objective of monetary policy is to maintain price stability while keeping in mind the objective of growth. Price stability is a necessary precondition to sustainable growth.
In 2016, the Reserve Bank of India Act, 1934, was amended to provide a statutory basis for the implementation of a flexible inflation-targeting framework, where the Centre and the RBI would review and agree upon a specific inflation target every five years.
Under this, 4% was set as the Consumer Price Index (CPI) inflation target for the period from August 5, 2016, to March 31, 2021, with the upper tolerance limit of 6% and the lower tolerance limit of 2%.
To the extent that ensuring price stability is its primary goal, the RBI through its MPC must constantly assess not just current levels of inflation and prices of various goods and services in the economy, but also take into consideration inflation expectations both of consumers and financial markets so as to use an array of monetary tools, including interest rates, to contain inflation within its target range.

The Centre has decided to retain the inflation target of 4%, with a tolerance band of +/- 2 percentage points for the Monetary Policy Committee of the RBI for the coming five years (April 1, 2021, to March 31, 2026).
Economists welcomed the continuity in the framework, despite the recent spate of high inflation prints beyond the 6% upper threshold of the inflation target.

In December 2020, a RBI working paper authored by RBI Deputy Governor Michael Debabrata Patra recommended that maintaining 4 per cent inflation is appropriate for India as targeting a lower rate could impart deflationary bias to the monetary policy.
The paper found a steady decline in trend inflation to 4.1-4.3 per cent since 2014.

The Monetary Policy Committee is a committee of the RBI which is entrusted with the task of fixing the benchmark policy interest rate (repo rate) to contain inflation within the specified target level.
The 2016 amendment of the Reserve Bank of India Act, 1934 provides for a statutory and institutionalised framework for the MPC.

The MPC has six members
- RBI Governor (Chairperson), RBI Deputy Governor in charge of monetary policy, one official nominated by the RBI Board and remaining 3 members would represent the Government.

The MPC makes decisions based on majority vote. In case of a tie, the RBI governor will have a second or casting vote.

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