RBI releases discussion paper on review of Monetary Policy Framework

Reserve Bank of India

The Reserve Bank of India (RBI) on August 21 released a discussion paper on review of Monetary Policy Framework and invited comments from stakeholders and members of the public by September 18.

In May 2016, the Reserve Bank of India Act, 1934 was amended to provide a statutory basis for the implementation of the flexible inflation targeting (FIT) framework in India. As per Section 45ZA of the RBI Act, 1934, the Central government shall, in consultation with the Reserve Bank, determine the inflation target in terms of the CPI, once in every five years.

The Central government initially notified the inflation target with the tolerance band on August 5, 2016, for the period 2016-2021. In the first review conducted in March 2021, this target was retained for the subsequent five years till March 2026. A second review of the target is now due by end-March 2026.

The discussion paper poses the questions such as whether headline inflation or core inflation would best guide the conduct of monetary policy, given evolving relative dynamics of food and core inflation and the continuing high weight of food in the CPI basket.

Further, it also poses questions such as whether the 4 per cent inflation target continues to remain optimal for balancing growth with stability in a fast growing, large emerging economy like India, Should the tolerance band around the target be revised in any way including whether the tolerance band be narrowed or widened or fully done away with, and should the target inflation level be removed, and only a range be maintained within the overall ambit of maintaining flexibility without undermining credibility?.

The discussion paper also said that in the years ahead, the conduct of inflation targeting as a monetary policy framework may face even greater challenges due to emerging geo-economic uncertainties, volatility of commodity prices, climate change and innovations in payment systems that can change the nature of policy trade-offs. Against this backdrop, this review gives us an opportunity to revisit some of the basic tenets of the framework to nudge the economy towards further improved macroeconomic outcomes in the best interest of all stakeholders.