Monetary Framework Under Review: RBI Explores Tweaks To Inflation Target And Tolerance Band

The Reserve Bank of India has released a discussion paper ahead of the second review of the monetary policy framework and inflation target due by end March 2026.

This paper undertakes a review of the nature and format of the extant inflation target, against the backdrop of the last nine years of India’s experience including the challenges faced during the pandemic and the post-pandemic era coupled with experience of inflation targeting advanced economies, and emerging market and developing economies.

As per Section 45ZA of the RBI Act, 1934, the Central Government, in consultation with the Reserve Bank of India, has to determine the inflation target in terms of the CPI, once in every five years. The inflation target was notified with the tolerance band on August 5, 2016, for the period 2016-2021.

The Act mandated the Reserve Bank to maintain a Consumer Price Index inflation target of 4% with the government notifying a tolerance band of +/- 2% around it on August 5, 2016 for the period 2016-2021. These features of the monetary policy framework, coupled with the accountability criteria that defined failure as three consecutive quarters of deviation of inflation from the tolerance band, came to be characterised as flexible inflation targeting.

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 inflation levels have seen a distinct decline with the average since adoption of flexible inflation targeting at 4.9% vis-à-vis an average of 6.8% over the pre-FIT period in the current series.

The discussion paper poses the following questions for feedback:

• 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?

• Whether the 4% 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?

• Should the target inflation level be removed, and only a range be maintained within the overall ambit of maintaining flexibility without undermining credibility?

  Comments on the issues for discussion can be sent by Sept. 18, 2025.

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 is intended as 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, the discussion paper said.