Skip to main content

What is inflation targeting by RBI?

Maintaining price stability in the economy is one of the objectives of Reserve Bank of India’s (RBI’s) monetary policy. Why is RBI obligated to manage inflation in the economy? What is the inflation target set for RBI? When can RBI be said to have failed to meet the inflation target? And what if RBI fails to keep the inflation within the set target?

What is the history of monetary policy framework in India?

Earlier, multiple indicator approach was followed by RBI which involved monetary policy decisions based on various indicators like credit, output, inflation, capital flows, etc. However, the multiple indicators approach was criticised of failing to provide a clear target for monetary policy due to a large set of indicators.

In 2014, Expert Committee set up by RBI to revise and strengthen monetary policy framework (Chairman: Dr. Urjit Patel) recommended the inflation targeting. In 2015, RBI signed a Monetary Policy Framework Agreement (MPFA) with the Government of India and took a target to bring down inflation in a sequential manner.

Further in May 2016, with amendment to RBI Act, 1934, flexible inflation targeting (FIT) was adopted by setting a target of 4% CPI-Combined inflation with tolerance band of +/- 2%, while simultaneously focusing on growth.

What amendments were made to RBI Act, 1934 for inflation targeting?

  • In May 2016, the preamble of RBI Act, 1934 was amended to add, “Primary objective of monetary policy is to maintain price stability while keeping in mind the objective of growth”. 
  • Further, Chapter IIIF on Monetary Policy was added to RBI Act, 1934, with guidelines on inflation targeting, monetary policy committee, etc.

What is the inflation target for RBI? (Section 45ZA of RBI Act, 1934)

As per RBI Act, 1934, inflation target is to be reviewed by the Government of India (in consultation with RBI) every 5 years. 

On August 5, 2016, the medium-term inflation target was decided as 4% CPI-combined inflation with a tolerance band of +/- 2% for the period up to March 31, 2021.

The inflation target was reviewed in March 2021 and March 2026 and retained for a further 5-year period up to March 31, 2026 and March 31, 2031, respectively.

What is Monetary Policy Committee (MPC)? (Section 45ZB, 45ZC & 45ZI of RBI Act, 1934)

Prior to the setting up of Monetary Policy Committee (MPC), the Technical Advisory Committee (TAC) on monetary policy with experts from the fields of economics and finance would advise RBI on the stance of monetary policy. However, its role was only advisory in nature and final decision would be taken by Governor of RBI.

With the amendment to RBI Act, 1934 in May 2016, MPC was set up to decide on the policy rate (i.e. repo rate) with the objective to keep the inflation within the set target. MPC consists of 6 persons – 

  1. Governor of RBI (chairperson)
  2. Deputy Governor of RBI, in-charge of monetary policy (member)  
  3. One officer of RBI nominated by Central Board (member)  
  4. Three persons appointed by the Central Government (members) – term of 4 years, not eligible for reappointment
The above three members of MPC are appointed by the Central Government on the recommendation of search-cum-selection committee consisting of –
  1. Cabinet secretary (chairperson)
  2. Governor of RBI / his representative Deputy Governor (member)
  3. Secretary, Department of Economic Affairs (member) 
  4. Three experts from field of economics / banking / finance / monetary policy, nominated by the Central Government (members)

MPC meets on bi-monthly basis (i.e. in April, June, August, October, December, February). The MPC’s decision is taken by votes and each member has one vote. In case of equality of votes, Governor can have 2nd / casting vote.

What are the publications relating to monetary policy? (Section 45ZL & 45ZM of RBI Act, 1934)

On the 14th day, after every meeting of the MPC, RBI shall publish minutes of the meeting which shall include –

  1. Resolution adopted by MPC
  2. Vote of each member
  3. Statement of each member on the resolution adopted

RBI shall publish Monetary Policy Report once in every 6 months explaining – 

  1. Sources of inflation
  2. Forecast of inflation for 6-18 months from the publication of the document

When can RBI be said to have failed to achieve the inflation target?

As notified by Central Government, RBI can be said to have failed to achieve the inflation target if the average inflation is –

  • More than 6% for 3 consecutive quarters 
  • Less than 2% for 3 consecutive quarters 

What shall RBI do if it fails to achieve the inflation target? (Section 45ZN of RBI Act, 1934)

If RBI fails to meet the inflation target, it shall report to the Central Government – 

  1. Reasons for the failure
  2. Remedial action proposed to be taken 
  3. Estimated time to achieve the inflation target

Which are the other countries following inflation targeting approach?

New Zealand went for inflation targeting in 1989 for the first time in the world. The other countries who have adopted inflation targeting are Canada, UK, Australia, Brazil, South Africa, Indonesia, USA, Japan, Russia, South Korea, etc. 


References

Reserve Bank of India. (2014, January 10). 'Report of the Expert Committee to Revise and Strengthen the Monetary Policy Framework'. Retrieved from https://rbidocs.rbi.org.in/rdocs/PublicationReport/Pdfs/ECOMRF210114_F.pdf

Reserve Bank of India. (2018, January 15). 'Functions and Workings of RBI'. Retrieved from https://rbidocs.rbi.org.in/rdocs/Publications/PDFs/RWF15012018_FCD40172EE58946BAA647A765DC942BD5.PDF

Reserve Bank of India. (2021, February 26). 'Chapter I: Flexible Inflation Targeting (FIT) in India'. Retrieved from https://www.rbi.org.in/scripts/PublicationsView.aspx?id=20342

Reserve Bank of India. (2022, August 29). 'The Reserve Bank of India Act, 1934'. Retrieved from https://rbi.org.in/Scripts/OccasionalPublications.aspx?head=Reserve%20Bank%20of%20India%20Act

Reserve Bank of India. (n.d.). 'Monetary Policy - Overview'. Retrieved from https://rbi.org.in/scripts/FS_Overview.aspx?fn=2752


Follow at - Telegram   Instagram   LinkedIn   Twitter

Labels:

Comments

Post a Comment

Popular Posts

Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR)

Reserve Bank of India (RBI) has issued the directions on maintenance of Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR) by banks. To whom are the directions applicable? The directions are applicable to the following Regulated Entities (REs) – Commercial Banks  Small Finance Banks (SFBs) Payments Banks (PBs) Local Area Banks (LABs) Regional Rural Banks (RRBs) Primary (Urban) Co-operative Banks (UCBs) Rural Co-operative Banks – State Co-operative Banks (StCBs) District Central Co-operative Banks (DCCBs) What is CRR? Every bank shall maintain in India by way of cash reserve, a sum equivalent to such percent of its Net Demand and Time Liabilities (NDTL) in India, as the RBI in terms of Section 42(1) of the RBI Act, 1934 (for scheduled banks) and Section 18(1) of the Banking Regulation Act (BR Act), 1949 (for non-scheduled banks) [including provisions of Section 18(1) of the BR Act as applicable to co-operative banks], may specify. What is incremental CRR? In terms of Secti...
Post a Comment
Read more

Special Rupee Vostro Accounts (SRVAs)

Reserve Bank of India (RBI) has consolidated the guidelines governing Special Rupee Vostro Accounts (SRVAs). Who can open and maintain Special Rupee Vostro Accounts (SRVAs)? Authorised Dealer (AD) banks in India may open Special Rupee Vostro Accounts (SRVAs) of its branch outside India or a bank resident outside India. Which transactions can be settled through SRVA? The settlement of cross-border trade transactions through SRVA is an additional arrangement for invoicing, payment and settlement of exports and imports in Indian Rupee (INR).  All permissible capital and current account transactions under Foreign Exchange Management Act (FEMA) may be settled through the SRVA.  AD banks maintaining SRVA are permitted to open additional current account for exporter / importer, exclusively for settlement of export / import transactions. What can be the source and use of funds in SRVA? SRVA may be funded by way of inward remittances or transfer from other repatriable INR accounts in t...
Post a Comment
Read more

Credit Cards and Debit Cards

Reserve Bank of India (RBI) has issued directions on issuance of credit cards and debit cards. To whom are the directions applicable? The directions are applicable to the following Regulated Entities (REs) – Commercial Banks  Small Finance Banks (SFBs) Regional Rural Banks (RRBs) Primary (Urban) Co-operative Banks (UCBs) Non-Banking Financial Companies (NBFCs) for all layers – NBFC-Investment and Credit Companies (NBFC-ICC) NBFC-Factor  NBFC-Micro Finance Institutions (NBFC-MFI)  Housing Finance Company (HFC)  What is a credit card? Credit Card is a physical / virtual payment instrument issued with a pre-approved revolving credit limit that can be used to purchase goods and services or draw cash advances. What is a debit card? Debit Card is a physical / virtual payment instrument linked to a Savings Bank / Current Account which can be used to withdraw cash, make online payments, do Point of Sale (PoS) terminal / Quick Response (QR) code transactions, fund transfer, e...
Post a Comment
Read more

Payment of Agency Commission to Agency Banks (ABs) and Disbursement of Government Pension by ABs

Reserve Bank of India (RBI) has issued guidelines on the conduct of Government business by Agency Banks (ABs), payment of agency commission to ABs and disbursement of Government pension by ABs. Who are ABs? ABs mean all Public Sector Banks (PSBs), scheduled Private Sector Banks (PVBs), scheduled Payments Banks (PBs), and scheduled Small Finance Banks (SFBs) appointed by the RBI under Section 45 of the RBI Act, 1934, by mutual agreement, to carry out Government banking business of the Central Government (CG) / State Governments (SGs). What is agency commission? Agency commission means the remuneration paid by the RBI to an AB in consideration of it acting as an agent of the RBI in the conduct of general banking business of the CG and the SGs at the places and in the manner specified in the agreement between the RBI and the bank, with the exception of the functions relating to the management of the public debt. What are the guidelines on appointment of ABs? Any eligible bank which intend...
Post a Comment
Read more

Highlights of RBI Annual Report 2025-26 – Chapter 7 to 12

Reserve Bank of India (RBI) has published its annual report for the financial year 2025-26. In a series of articles, we will go through the highlights of the report. This is the fifth and final article in the series.  Chapter 7 – Public Debt Management The ways and means advances (WMA) limit for the Government of India (GoI) for H1:2025-26 (April to September 2025) was fixed at ₹1,50,000 crore and for H2:2025-26 (October 2025 to March 2026) was fixed at ₹50,000 crore. The RBI entered into an agreement with the Government of National Capital Territory of Delhi (GNCTD), under Section 21A(1) of the RBI Act, 1934, to carry on the general banking business of GNCTD and manage its rupee public debt. The WMA limit of GNCTD was set at ₹890 crore, taking the aggregate WMA limit of all the states / UTs to ₹61,008 crore. The RBI introduced Separate Trading of Registered Interest and Principal of Securities (STRIPS) in the state government securities. Retail Direct Gilt (RDG) account – An au...
Post a Comment
Read more