Related Notes: 1. [Inflation](Inflation.md) 2. [[Inflation and RBI]] 3. [Monetary Policy Frameworks in India](Monetary%20Policy%20Frameworks%20in%20India.md) 4. [2016 - FIT framework and formation of Monetary Policy Committee (MPC)](Monetary%20Policy%20Decisions%20in%20the%20RBI%20-%20The%20Structure.md#2016%20-%20FIT%20framework%20and%20formation%20of%20Monetary%20Policy%20Committee%20(MPC)) 5. [Monetary Policy Decisions in the RBI - The Structure](Monetary%20Policy%20Decisions%20in%20the%20RBI%20-%20The%20Structure.md) >==Flexible Inflation Targeting (FIT) is the current monetary policy framework adopted on May 14, 2016, and it became operational in October 2016.== ## Timeline 1. [Box I.9 Inflation Targeting Framework: Institutional Arrangements](RBI_Annual%20Report_2007.pdf#page=73&selection=95,0,96,57) in RBI's Annual Report-2007 2. In the post-global financial crisis period, that is post 2008, the credibility of multiple indicators approach (framework) came into question as persistently high inflation and weakening growth began to co-exist. 1. In the face of double-digit inflation of 2012-13, the US Fed’s taper talk in May/June 2013 posed significant challenges to domestic monetary policy for maintaining the delicate balance between sustaining growth, containing inflation and securing financial stability. 2. The extant multiple indicators approach was criticized on the ground that a large set of indicators do not provide a clearly defined nominal anchor for monetary policy. 3. [Jan 21, 2014](https://rbi.org.in/scripts/BS_PressReleaseDisplay.aspx?prid=30446)- The [Expert Committee](RBI_Group-Committee_2014_The%20Expert%20Committee%20to%20Revise%20and%20Strengthen%20the%20Monetary%20Policy%20Framework-2014_Chairman-Urijit%20R.%20Patel.pdf) to Revise and Strengthen the Monetary Policy Framework, chaired by Dr. Urjit Patel, during the tenure of [[Raghuram G. Rajan]] submitted its report. 1. It reviewed the multiple indicators approach and recommended that inflation, as measured by headline All India [CPI-Combined](Inflation.md), should be the nominal anchor for the monetary policy framework. 2. An explicit glide path for disinflation was also suggested. 3. [More here](Monetary%20Policy%20Frameworks%20in%20India.md#2014) 4. [April 1, 2014](RBI_MPS_201404_1.pdf)- In the First Bi-monthly Monetary Policy Statement 2014–15, RBI officially adopted the headline [CPI](Inflation.md) (Consumer Price Index, rural and urban, combined) as its key measure (primary indicator) of inflation. 1. But there was no official numerical target for it. 2. It also imposed on itself a glide path for bringing down inflation in a phased manner, that is from the high of 11.5% in November 2013 to 8% by January 2015, 6% by January 2016 and 5% by Q4 2016-17. 3. Until April 1, 2014, RBI was articulating inflation concerns in terms of the WPI under a multiple indicator based monetary policy framework. [^1] 5. [February 20, 2015](GoI_Agreement_20150220_Agreement%20on%20Monetary%20Policy%20Framework%20between%20Govt.%20and%20the%20RBI.pdf) - An agreement called the the the [Monetary Policy Framework Agreement (MPFA)](https://rbi.org.in/scripts/BS_PressReleaseDisplay.aspx?prid=33361), was signed between Government of India and Reserve Bank of India, which would change the monetary policy approach from multiple indicator to flexible inflation targeting (FIT). 6. [May 14, 2016](Act_The%20Finance%20Act-2016_28%20OF%202016_May%2014%202016_CHAPTER%20XII-PART%20I.pdf) - The RBI Act was amended by the Finance Act, 2016, and Flexible Inflation Targeting (FIT) was formally adopted as the approach or framework for making of monetary policy in 2016. 1. The amended Act provided that the Central Government shall, in consultation with the Bank (RBI), determine the inflation target in terms of the headline Consumer Price Index (CPI), that is year-on-year change in the monthly CPI, once in every five years, in accordance with sub-section (1) of section 45ZA 2. In other words, the formal statutory recognition for the FIT framework came with the passage of Finance Act, 2016. 7. [[Gazette Notification_June 27 2016_MPFA.pdf|June 27, 2016]] - The amended provisions for set up of the Monetary Policy Committee (MPC) were brought into force, and a formalized committee approach to monetary policy decision-making was established by the set up of a MPC, which had a statutory framework for setting India's monetary policy. 1. ==[More details on MPC](Monetary%20Policy%20Decisions%20in%20the%20RBI%20-%20The%20Structure%20OPEN.md#2016%20-%20FIT%20framework%20and%20formation%20of%20Monetary%20Policy%20Committee%20(MPC)== 8. [August 5, 2016](GoI_PIB%20Press%20Release_20160805_Statutory%20and%20Institutionalised%20framework%20for%20Monetary%20Policy;%20Central%20Government%20in%20consultation%20with%20RBI%20announces%20the%20Inflation%20Target%20of%20Four%20Percent.pdf) - Central Government in consultation with RBI announced the inflation target of 4% in terms of CPI, with an upper tolerance level of 6% and a lower tolerance level of 2%, internalizing flexibility. 1. In other words, headline [[Inflation|CPI inflation]] (combined-rural and urban) became the anchor of the monetary policy approach, with a target of 4% with a deviation of 2%. 2. An [example](https://mospi.gov.in/sites/default/files/press_release/CPI_PR_12june24.pdf) of CPI data release for May 2024, released on June 12, 2024. 9. [September 29, 2016](PIB_20160929_Monetary%20Policy%20Committee%20constitution%20under%20the%20Reserve%20Bank%20of%20India%20Act,%201934%20notified.pdf) - Government of India (GoI) notified (informed the world) about the appointment of the MPC. 10. ==Operationalisation of FIT [(October 4, 2016)](RBI_MPS_R-MPC_201610.pdf) - The first meeting of MPC (which was also the 4th bi-monthly monetary policy announcement) took place.== 11. With this, India joined the group of several developed and emerging market economies that have implemented inflation targeting 1. What was underlying this new framework was the consensus between RBI and the govt. that the central bank must be able to operate freely to set the rate of interest and the policy relating to expansion or contraction of liquidity. [^3] 2. It restored the autonomy with respect to monetary policy. 3. **Price stability became the major objective of the policy**, while simultaneously focusing on growth when inflation is under control. 4. The relative emphasis on inflation and growth would depend on the macroeconomic scenario, inflation and growth outlook, and signals emerging from incoming data. 5. Since then RBI has been conducting monetary policy in a forward-looking manner and effectively communicating its decisions to maintain inflation around its target and thereby to support growth. 6. What inflation targeting demands is that when inflation goes beyond the comfort zone, the exclusive concern of monetary policy must be to bring it back to the target level. When inflation is within the comfort zone, authorities can look to other objectives. [^2] 7. At the same time, RBI has also fine-tuning its operating procedures (liquidity management, implemented through LAF and other instruments) of monetary policy for effective policy transmission across the financial markets and thereby onto the real economy. [^2] 8. [More](Monetary%20Policy%20Frameworks%20in%20India.md#2016%20-%20Flexible%20Inflation%20Targeting) on liquidity management by RBI. 12. <span style="background-color:#F0FFFF;">With the end of multiple indicators approach in 2015 and adoption of FIT followed by setting up of MPC, the issue of disagreements between the finance ministry and the RBI over the rate of interest, which started after the process of discontinuation of the issue of ad-hoc treasury bills was initiated in 1992 and the interest rates getting determined by the market, has somewhat eased.</span> 13. In other words, it was expected that if FIT regime is successfully adopted, the tension between RBI and the govt. over the level of cost of borrowing would be resolved. 14. What inflation targeting demands is that when inflation goes beyond the comfort zone, the exclusive concern of monetary policy must be to bring it back to the target level. When inflation is within the comfort zone, authorities can look to other objectives. [^2] 15. ==[But can RBI really control Inflation?](Inflation%20and%20RBI.md)== #inflation >==The [Report on Currency and Finance (2020-21)](20210226_Report%20on%20Currency%20and%20Finance_2020-21.pdf)Report on Currency and Finance (2020-21) has the theme-Reviewing The Monetary Policy Framework.== >The period of study in this report is from October 2016 to March 2020 commencing with the formal operationalisation of the flexible inflation targeting (FIT) framework in India but excluding the period of the COVID-19 pandemic in view of data distortions. ## Inflation Targets 1. The Central Government, in consultation with the RBI determines this inflation target in terms of the Consumer Price Index, once in every five years, which needs to be notified in the Official Gazette. This is covered in Section 45-ZA, RBI Act, 1934. 2. [August 5, 2016](GoI_PIB%20Press%20Release_20160805_Statutory%20and%20Institutionalised%20framework%20for%20Monetary%20Policy;%20Central%20Government%20in%20consultation%20with%20RBI%20announces%20the%20Inflation%20Target%20of%20Four%20Percent.pdf) - From the 29-September-2016 to March 31, 2021, that is for a period of 5 years, notified on August 5, 2016, inflation target was set as under: 1. Inflation Target: 4% 2. Upper tolerance level: 6% 3. Lower tolerance level: 2% 3. ==Although concerns about inflation had dominated monetary policy over the past decades, also because policymakers accepted the society's intolerance threshold for inflation, such an explicit commitment to a numerical inflation target as the focus of the policy was never made.== 4. March 31, 2021 - On March 31, 2021, the Government retained the previous inflation target for the next five years (April 2021-March 2026). [Governor’s Statement, April 7, 2021](https://rbi.org.in/scripts/BS_PressReleaseDisplay.aspx?prid=51380) 1. On March 31, 2021, the Government retained the inflation target at 4 per cent with the lower and upper tolerance levels of 2 per cent and 6 per cent, respectively, for the next five years (April 2021-March 2026). An inflation rate of 4 per cent over the medium term has now been successfully entrenched in the economic landscape. 2. ==The experience with efficaciously maintaining price stability and the gains in credibility for monetary policy since the beginning of the inflation targeting framework in 2016 are reinforced by the retention of the target and the tolerance band.== 3. From the time after the Monetary Policy Committee (MPC) was constituted in September 2016, average CPI inflation for the period October 2016 to February 2020 – prior to the onset of the COVID-19 pandemic – was 3.8 per cent, down from the average of 7.3 per cent during January 2012 to September 2016. 4. Our research suggests that trend inflation has moderated during the flexible inflation targeting period to around 4 per cent in recent times. 5. The experience during the COVID-19 period has testified to the flexibility of the framework to respond to sharp growth-inflation trade-offs and extreme supply-side shocks over the course of the business cycle. 6. Monetary policy over the next five years would aim at consolidating and building upon the credibility gains of the first 5 years of flexible inflation targeting. ## Failure to meet the target under FIT? **What will be a Failure to meet the target under FIT?** 1. The amended RBI Act, in terms of section 45ZN, has also [specified](What%20will%20be%20a%20Failure%20to%20meet%20FIT_June%2027_2016.pdf) that the following factors woud constitute failure to achieve the inflation target, namely 1. If the average inflation is more than or less than the upper tolerance level or lower tolerance level of the inflation target for any three consecutive quarters, it would be regarded as a [[What will be a Failure to meet FIT_June 27_2016.pdf|failure]] to meet the target. 2. RBI is required to provide the reasons for the failure, suggest remedial measures and the expected time to return inflation to the target. 3. In other words, it defines failure as average inflation breaching the tolerance band for three consecutive quarters, not instantly. ## Challenges 1. Few challenges for RBI are: 1. Supply-side (agri shocks) pressures leading to volatile food prices (and fuel), which have a larger impact on the dynamics of headline inflation 2. Changing (anchoring) inflation expectations and the uncertainty 3. Weaker (or inefficient) [[Monetary Policy Transmission OPEN|monetary policy transmission]] mechanism 4. Lack of fiscal prudence 5. CPI as inflation index 6. selection of inflation targets 1. India is a moderate inflation country with the long-term average inflation rate remaining in a single digit of about 7.5 per cent since 1970–71. Just for 2000, the average is 5.5% [^3] 2. **Few upside and downside risks to Inflation?** >==About the FIT framework (*Must Read) - Inflation-Forecast Targeting For India: An Outline of the Analytical Framework. RBI WPS (DEPR): 07/2016 (RBI Working Paper Series No. 07 of 2016). [Link](https://rbi.org.in/scripts/PublicationsView.aspx?Id=17393)== ## Resource Library ### [[Speeches & Media Interactions|Speeches]] 1. Deepak Mohanty. Mar 02, 2010 .==Monetary Policy Framework in India: Experience with Multiple-Indicators Approach.== (Speech by Shri Deepak Mohanty, Executive Director, Reserve Bank of India, delivered at the Conference of the Orissa Economic Association in Baripada, Orissa, on 21st February 2010. [Link](https://rbi.org.in/scripts/BS_SpeechesView.aspx?Id=481) 2. Michael Debabrata Patra. Oct 15, 2024. ==Assessing Inflation Targeting==. Address delivered by Michael Debabrata Patra, Deputy Governor, Reserve Bank of India - October 14, 2024 - at the High Level Conference “Central Banking at Crossroads” organised by the Reserve Bank of India as apart of commemoration of its 90th year at New Delhi, India. [Link](https://rbi.org.in/scripts/BS_SpeechesView.aspx?Id=1471) 3. Shaktikanta Das. (Jan 24, 2020). ==Seven Ages of India’s Monetary Policy==. (Shri Shaktikanta Das, Governor, Reserve Bank of India - January 24, 2020 - at the St. Stephen's College, University of Delhi). [Link](https://rbi.org.in/scripts/BS_SpeechesView.aspx?Id=1092) ### [[Publications (Data Releases) & Research#Publications|Publications]] 1. RBI. (Aug 30, 2007). Box I.9 Inflation Targeting Framework: Institutional Arrangements. RBI's Annual Report-2007. [pdf](RBI_Annual%20Report_2007.pdf#page=73&selection=95,0,96,57) 2. ==RBI. (Feb 26, 2011). Chapter I: Flexible Inflation Targeting (FIT) in India in the "Report on Currency and Finance".== [Link](https://rbi.org.in/scripts/AnnualPublications.aspx?head=Report%20on%20Currency%20and%20Finance) 3. RBI. (Feb 26, 2021). ==Chapter II: The Goals of Monetary Policy in "Report on Currency and Finance".== [Link](https://rbi.org.in/scripts/PublicationsView.aspx?Id=20343) 4. RBI. (Feb 26, 2021). ==Chapter V: Open Economy Flexible Inflation Targeting "Report on Currency and Finance-2020-21".== [Link](https://rbi.org.in/scripts/PublicationsView.aspx?Id=20346) ### [[Publications (Data Releases) & Research#Research|Research]] [[Working Paper Series (WPS)|Working Paper Series (RBI)]] 1. (Nov 25, 2016). ==Inflation-Forecast Targeting For India: An Outline of the Analytical Framework.== RBI WPS (DEPR): 07/2016 (RBI Working Paper Series No. 07 of 2016). Authors - Jaromir Benes, Kevin Clinton, Asish Thomas George, Joice John, Ondra Kamenik, Douglas Laxton, Pratik Mitra, G.V. Nadhanael, Hou Wang and Fan Zhang. [Link](https://rbi.org.in/scripts/PublicationsView.aspx?Id=17393) 2. Joice John, Sanjay Singh and Muneesh Kapur. (Sep 24, 2020). ==Inflation Forecast Combinations – The Indian Experience.== RBI WPS (DEPR): 11/2020. [Link](https://rbi.org.in/scripts/PublicationsView.aspx?Id=19977) 3. Harendra Kumar Behera and Michael Debabrata Patra. (Dec 28, 2020). ==Measuring Trend Inflation in India.== RBI WPS (DEPR): 15/2020. [Link](https://rbi.org.in/scripts/PublicationsView.aspx?Id=20262) 1. This paper began with a question that goes to the root of FIT in India – is the choice of the target for inflation consistent with its trend? 4. Saurabh Sharma and Ipsita Padhi. Dec 16, 2021. ==An Alternative Perspective on Demand and Supply to Forecast Inflation.== RBI WPS (DEPR): 06/2021. [Link](https://rbi.org.in/scripts/PublicationsView.aspx?Id=20936) 5. Silu Muduli and Himani Shekhar. (Jan 12, 2023). ==Tail Risks of Inflation in India==. RBI WPS (DEPR): 02/2023. [Link](https://rbi.org.in/scripts/PublicationsView.aspx?Id=21627) 6. Purnima Shaw. (Apr 18, 2023). ==Reading Consumers’ Minds: An Analysis of Inflation Expectations==. RBI WPS (DEPR): 05/2023. [Link](https://rbi.org.in/scripts/PublicationsView.aspx?Id=21762) 7. Edwin Prabu A, Indranil Bhattacharyya. (Jul 04, 2023). ==Regime-Dependent Determinants of the Uncollateralised Overnight Rate: The Interplay of Operating Procedure and Market Microstructure==. RBI WPS (DEPR): 07/2023. [Link](https://rbi.org.in/scripts/PublicationsView.aspx?Id=21790) 8. RBI. (Oct 03, 2024). ==Pulses Inflation in India: A Study of Gram, Tur and Moong==. RBI WPS (DEPR): 07/2024. Authors-Shyma Jose, Sanchit Gupta, Manish Kumar Prasad, Sandip Das, Asish Thomas George, Thangzason Sonna, D. Suganthi and Ashok Gulati. [Link](https://rbi.org.in/scripts/PublicationsView.aspx?Id=22722) 9. Oct 03, 2024. ==Livestock and Poultry Inflation in India: A Study of Milk, Poultry Meat and Eggs.== RBI WPS (DEPR): 05/2024. Authors-Shyma Jose, Manish Kumar Prasad, Sabarni Chowdhury, Binod B. Bhoi, Vimal Kishore, Himani Shekhar and Ashok Gulati. [Link](https://rbi.org.in/scripts/PublicationsView.aspx?Id=22720) [[DRG Studies Series|DRG Studies]] 1. RBI. (Jul 06, 2023). DRG Study No. 49: ==Anatomy of Price Volatility Transmission in Indian Vegetables Market==. [Groups/Committees](app://obsidian.md/Groups%20and%20Committees.md) 1. [Jan 21, 2014](https://rbidocs.rbi.org.in/rdocs/PublicationReport/Pdfs/ECOMRF210114_F.pdf) - <span style="background-color:#F0FFFF;">Report of the Expert Committee to Revise and Strengthen the Monetary Policy Framework, chaired by Urjit Patel</span> ### [Press Releases & Notifications](https://rbi.org.in/Scripts/BS_PressReleaseDisplay.aspx) 1. RBI. (April 7, 2021). ==Governor’s Statement== (post Monetary Policy Committee (MPC) meetings on 5th, 6th and 7th April, 2021). [Link](https://rbi.org.in/scripts/BS_PressReleaseDisplay.aspx?prid=51380) ### Others 1. Patrick Blagrave and Weicheng Lian (Nov, 2020). ==India’s inflation process before and after flexible inflation targeting.== (IMF Working Paper No. WP/20/251). International Monetary Fund. [Link](https://www.imf.org/-/media/files/publications/wp/2020/english/wpiea2020251-print-pdf.pdf) 2. Rakesh Mohan, Partha Ray. (May 4, 2018). ==Indian Monetary Policy in the Time of Inflation Targeting and Demonetisation==. Brookings India Working Paper 4, May 2018. [Link](https://www.brookings.edu/wp-content/uploads/2018/06/Final-Monetary-Policy.pdf) 3. Radhika P, Ila P & Rajeswari S. (Oct, 2024). ==The journey of inflation targeting in India==. IGIDR. [Link](http://www.igidr.ac.in/pdf/publication/WP-2024-022.pdf) [^1]: Michael Debabrata Patra. (Nov 20, 2017. ==One Year in the Life of India's Monetary Policy Committee==. (Dr. Michael Debabrata Patra, Executive Director - October 27, 2017 - at the Jaipur Regional Office of the Reserve Bank of India. [Link](https://rbi.org.in/scripts/BS_SpeechesView.aspx?Id=1050) [^2]: Shaktikanta Das. (Jan 24, 2020). ==Seven Ages of India’s Monetary Policy==. (Shri Shaktikanta Das, Governor, Reserve Bank of India - January 24, 2020 - at the St. Stephen's College, University of Delhi). [Link](https://rbi.org.in/scripts/BS_SpeechesView.aspx?Id=1092) [^3]: Deepak Mohanty. Mar 02, 2010 .==Monetary Policy Framework in India: Experience with Multiple-Indicators Approach.== (Speech by Shri Deepak Mohanty, Executive Director, Reserve Bank of India, delivered at the Conference of the Orissa Economic Association in Baripada, Orissa, on 21st February 2010. [Link](https://rbi.org.in/scripts/BS_SpeechesView.aspx?Id=481)