The Monetary Policy Mirage, Is India’s Inflation Targeting Regime Built on Shifting Sands?
For nearly a decade, the cornerstone of India’s macroeconomic stability has been a formal, legislated Inflation Targeting (IT) framework. Since 2016, the Reserve Bank of India (RBI) has been mandated to maintain Consumer Price Index (CPI) inflation at 4%, with a tolerance band of +/- 2%. This regime, lauded for providing transparency and anchoring expectations, is now approaching a critical juncture. Its statutory review in March 2026 coincides with a period of intense introspection, prompted by the roller-coaster volatility of the past year. As scholars Abhiman Das and Smitarov Trivedi articulate, headline inflation has swung dramatically, driven almost entirely by food prices, while the RBI’s primary tool—the policy interest rate—has seemed a spectator to the main event. This dissonance forces a fundamental reappraisal: Has the inflation targeting regime truly tamed India’s price pressures, or has its success been a fortunate byproduct of favourable monsoons and government supply-side interventions? Is it time for a more pragmatic, India-specific monetary policy framework that looks beyond a rigid numerical target?
The Volatile Crucible: A Year of Food-Price Whiplash
The last fiscal year has been a masterclass in the unique challenges of Indian inflation. In late 2024, food inflation soared above 7%, pushing the headline CPI uncomfortably close to 5.5%. By mid-2025, the picture had inverted: food inflation had collapsed to less than 2%, dragging headline inflation below 4%, and even breaching the 2% lower bound of the RBI’s target range. Throughout this wild swing, the Monetary Policy Committee (MPC) adjusted the repo rate with calibrated caution, yet the causal link between these adjustments and the ultimate path of inflation was tenuous at best. The undeniable driver was the dramatic rise and fall of food prices—a sector notoriously impervious to interest rate signals. A farmer deciding crop patterns or a government managing buffer stocks is largely indifferent to whether the repo rate is 6.5% or 6.25%. This experience lays bare the core dilemma: India’s headline inflation is, in essence, food inflation in disguise, with a staggering correlation coefficient of 0.86, as the authors note. The RBI’s mandate targets the symptom (headline CPI), but its medicine (interest rates) is designed for a different disease (demand-pull inflation in the core economy).
Interrogating the “Success”: Correlation or Causation?
Proponents of the IT regime point to a simple, compelling chart: average CPI inflation has been lower and more stable in the post-2016 period compared to the tumultuous years preceding it. This is true. However, as Das and Trivedi argue, establishing a causal link from the adoption of IT to this stability is fraught with logical pitfalls. The annual average CPI has exceeded the 4% target in six of the nine years under the regime. More critically, a global perspective complicates the narrative. Research indicates that a broad, secular decline in inflation has been observed across many emerging market economies in the last decade, irrespective of whether they adopted an IT framework. This global disinflationary trend, driven by factors like benign global commodity prices (until recent shocks) and technological advances, suggests India’s relative stability may not be solely—or even primarily—a monetary policy triumph.
The trajectory of core inflation—which excludes volatile food and fuel prices and represents underlying demand pressures—is particularly revealing. Core inflation has proven stubborn, often persisting above 4% even when headline inflation plummets due to a food price crash. This suggests that interest rate policy, while perhaps preventing core inflation from spiraling higher, has not been the decisive force in achieving the target. The “success” in hitting the headline number has frequently been a function of favourable food supply conditions, a variable outside the MPC’s purview. This raises a profound question of accountability: Should the RBI’s credibility be judged on its ability to control prices it cannot influence?
The Tyranny of the Food Basket: Targeting Headline vs. Core
This leads to the central technical debate: Should the RBI target headline CPI or core CPI?
The current mandate to target headline CPI is often defended as “pragmatic” because it reflects the actual cost-of-living burden faced by households, especially the poor for whom food constitutes a much larger share of expenditure. It ensures the central bank remains accountable to the public’s lived experience of inflation. However, its fatal flaw is that it forces the RBI to react—or appear to react—to supply shocks it cannot remedy. Raising interest rates to combat inflation caused by a poor monsoon or vegetable price spikes is not just ineffective; it actively harms the broader economy by stifling investment and consumption in the non-food sectors, which are sensitive to borrowing costs.
Targeting core CPI is the orthodox alternative. It would allow the MPC to focus on the component of inflation its tools can actually affect: demand-side pressures in the industrial and services economy. This could lead to more stable and predictable monetary policy. However, it comes at the cost of political and communicative difficulty. Explaining to a public reeling from high onion and tomato prices that the central bank is “looking through” this volatility because core inflation is stable is a near-impossible communications challenge. It could severely dent the hard-won credibility of the institution.
The authors present a crucial insight: India’s food inflation exhibits strong mean reversion. It spikes but eventually falls back, often due to seasonal and policy factors. This inherent volatility has, paradoxically, helped the RBI achieve its target over a medium-term horizon, as high periods are offset by low periods. However, this is a fragile foundation for a policy regime. Furthermore, proposed revisions to the CPI, which may lower the weight of food in the basket, could ironically make the RBI’s task harder. With food’s dampening volatility playing a smaller role, missing the target due to persistent core inflation could become more frequent.
The Chimera of Anchored Expectations
A primary theoretical benefit of IT is the anchoring of inflation expectations. If households and businesses believe the central bank will deliver 4% inflation, they will base their wage and price-setting behavior on that belief, creating a self-fulfilling prophecy. But in India, where food purchases are a daily, visceral experience for hundreds of millions, inflation expectations are overwhelmingly shaped by the prices of rice, wheat, pulses, and vegetables, not by abstract faith in the RBI’s resolve. As the authors state, “there is no other way to achieve [anchored expectations] other than by sustaining a low and less volatile food inflation.”
This places the onus squarely on the government. Effective inflation management in India is, and will remain, a dual responsibility: the RBI manages demand-side pressures in the formal economy, while the government must manage the supply-side of the food economy through strategic buffer stocks, efficient supply chains (e.g., Operation Greens), trade policies (export bans/import duties), and long-term agricultural productivity investments. The current framework awkwardly assigns the RBI a target it cannot achieve alone, while the government’s crucial role lacks a similarly transparent and accountable metric.
Charting a Pragmatic Path Forward: Beyond Rigid Targeting
As the 2026 review approaches, a pragmatic evolution of the framework is necessary, not its abandonment. Several reforms could make it more fit for India’s purpose:
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Explicit Dual Mandate or a Flexible Average: The mandate could be formally expanded to include growth and employment more explicitly, as with the US Federal Reserve. Alternatively, the target could shift from a point (4%) to a medium-term average (e.g., 4% over a 3-5 year business cycle), giving the MPC flexibility to “look through” transient food shocks without losing credibility.
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Enhanced Coordination and Clarity: A formal, public mechanism for coordination between the RBI and the government on food supply management is needed. The RBI’s monetary policy statements could include a dedicated section assessing supply-side conditions and government actions, clearly delineating the boundaries of its responsibility.
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Communicating a “Hierarchy of Objectives”: The RBI could communicate that while the headline CPI is the final target, its policy reactions will be primarily guided by the trajectory of core inflation and growth indicators, with food price volatility treated as a mitigating context rather than a primary trigger.
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Incorporating Distributional Analysis: As the authors suggest, given the disproportionate impact of food inflation on the poor, policy design should incorporate analysis of inflation’s effects across income quantiles, ensuring the welfare of the most vulnerable is central to the policy calculus.
Conclusion: From a Imported Framework to a Homegrown Model
India’s tryst with inflation targeting has provided valuable discipline and transparency. It has helped institutionalize a focus on price stability. However, the past year has exposed its limitations as a one-size-fits-all solution imported from advanced economies with structurally different inflation drivers. The RBI has been like a captain trying to steer a ship by adjusting the sails, while the currents and tides (food supply) determine its course.
The 2026 review must catalyze a shift from rigid targeting to pragmatic inflation management. The goal should be to craft a “Made-for-India” framework that acknowledges the primacy of food prices, clearly apportions accountability between monetary and fiscal authorities, and uses the interest rate tool where it is effective, without sacrificing the broader economy at the altar of a numerical target missed for reasons beyond its control. True monetary policy success is not just hitting a number, but fostering sustainable, inclusive growth with stable prices. It’s time for India’s framework to mature and reflect that complex, but essential, truth.
Questions & Answers
Q1: Why has the effectiveness of India’s Inflation Targeting (IT) regime been called into question recently?
A1: Its effectiveness is questioned because recent extreme volatility in headline CPI inflation has been driven almost entirely by food prices, which are largely immune to the RBI’s primary tool—interest rates. The RBI’s policy actions have appeared disconnected from the actual inflation outcomes, suggesting the regime’s “success” in maintaining target ranges may be more due to favourable food supply conditions (government action, monsoons) than to monetary policy itself.
Q2: What is the critical difference between targeting “headline CPI” and “core CPI,” and what are the trade-offs?
A2: Headline CPI includes all items, especially volatile food and fuel. Targeting it keeps the central bank accountable to the public’s lived cost-of-living experience but forces it to react to supply shocks it cannot control. Core CPI excludes food and fuel, focusing on demand-side pressures the RBI can influence. Targeting it would allow for more focused monetary policy but is politically and communicatively difficult, as it requires “looking through” price spikes that hurt households daily, risking a loss of public credibility.
Q3: According to the article, why is the anchoring of inflation expectations particularly challenging in India?
A3: Inflation expectations in India are predominantly shaped by frequent, direct purchases of food items, not by abstract trust in the central bank’s target. Households feel inflation through the price of vegetables, grains, and cooking oils. Therefore, expectations can only be anchored by sustaining low and stable food inflation, which is a supply-side issue managed by the government, not a demand-side issue managed by the RBI’s interest rates.
Q4: How does the phenomenon of “mean reversion” in food inflation complicate the assessment of the IT regime’s success?
A4: Food inflation in India tends to spike and then fall back to a long-term average due to seasonal and policy factors. This mean reversion has statistically helped the RBI achieve its medium-term target, as high periods are followed by low periods. However, this means the regime’s success is partially built on a volatile, exogenous factor, not on the steady hand of monetary policy, making the claimed success fragile and potentially misleading.
Q5: What pragmatic reforms are suggested for the monetary policy framework as the 2026 review approaches?
A5: Suggested reforms include: (1) Adopting a flexible average inflation target (e.g., 4% over a business cycle) to allow temporary food shocks to pass through; (2) Formally expanding the mandate to include growth and employment more explicitly; (3) Establishing better coordination and clarity between the RBI and government on supply-side management; and (4) Having the RBI communicate a “hierarchy of objectives” where core inflation and growth guide policy, with food prices as context. The goal is a more pragmatic, India-specific model.
