<p>By March 2026, India must decide whether to retain or modify the inflation targeting (IT) regime, which has been guided by a 4% Consumer Price Index (CPI) inflation target with a ±2% band since the 2016 amendment to the Reserve Bank of India (RBI) Act. The review will revisit familiar questions: Should the target remain at 4%? Should policy focus on headline or core inflation? Should the tolerance band be revised? While these questions are important, they overlook the core challenge. In an economy where supply shocks, bottlenecks, sectoral imbalances, and mark-up pricing alongside stagnant wages drive much of the volatility, the policy rate alone cannot shoulder the burden of price stabilisation. The review risks remaining inside the very frame that produces the trade-offs; it is the design of the framework, not just the settings, that deserves scrutiny.</p>.<p>While the IT framework has helped avoid persistent inflation, the 4% midpoint has not operated as a strong anchor, as inflation remained above 4% in most years, even if within the 6% tolerance band. The 6% tolerance band was breached in 2020-21 and 2022-23. This mixed evidence suggests credibility at the band level, but not at the midpoint. However, part of the difficulty lies not in policy calibration but in deeper structural changes in the economy. In the post-reforms era, services have grown faster and now account for a disproportionate share of income relative to output. This has created a structural imbalance, where incomes have grown faster in services while output growth in commodity-producing sectors has lagged, contributing to price pressures that are not responsive to IT. Hence, the IT review must go beyond the neoliberal policy frame and consider how monetary policy adapts to a changing global economic order and multipolar world.</p>.<p>Food, fuel, and other essential commodity prices, which drive headline inflation, respond to supply-side factors such as weather, global commodity cycles, geopolitical disruptions, import pass-through, supply chain inefficiencies, hoarding, and anti-competitive practices. Interest rate-based monetary policy cannot meaningfully contain such inflation.</p>.<p>Advocates of anchoring headline inflation raise concern that food inflation may feed into a wage-price spiral. However, the evidence shows wages have grown more slowly than GDP between 2014 and 2025, reflecting a pattern of long-term wage stagnation. Using interest rates to contain headline inflation, therefore, suppresses consumption without addressing the underlying causes of price increases. National Sample Survey Office (NSSO) data indicate that household consumption has grown significantly more slowly than GDP between 2011 and 2023, indicating a disproportional burden on the disadvantaged. Additionally, climate-related shocks have increased volatility in these components, and the current IT framework cannot manage them.</p>.<p>The difficulty is not inflation per se, but an IT framework that reduces stabilisation to a single lever, the repo rate, regardless of the source of inflation. In such a design, high rates often choke investments the economy needs in manufacturing and agriculture, while EMIs rise for the middle and upper-middle classes. Livelihood costs rise while the sources of inflation that are not rate-sensitive remain largely untouched. Over the past decade, growth has been uneven, with aggregate saving and investment hovering at around 30% of GDP, while manufacturing and agricultural output have grown modestly.</p>.<p>Additionally, the effectiveness of monetary policy is weakened due to segmented credit markets and frictions. The large, promoter-controlled, group-affiliated, and listed corporate groups are relatively insulated from policy tightening due to their market power and diversified financing options. In contrast, pass-through to medium, small, and micro enterprises (MSMEs) and households is partial and slow. Thus, tightening hurts more than easing helps.</p>.<p><strong>Profit-linked inflation</strong></p>.<p>Profit-linked inflation remains overlooked in mainstream debates in India. Evidence from advanced and emerging markets shows profits have accounted for a share of price increase, especially in concentrated markets where firms possess the power to set prices and can use supply shocks or cost volatility to expand mark-ups rather than merely pass on costs. In India, Motilal Oswal reports that the corporate profit-to-GDP ratio (4.7%) is now at a 17-year high.</p>.<p>Labour costs did not drive this episode. FICCI-Quess Corp finds compounded annual wage growth of 0.8% in engineering/manufacturing/ infrastructure, rising to 5.4% in FMCG. During the pandemic recovery, large firms deleveraged, improving their balance sheets. Household purchasing power lagged, and household debt stood at about 42% of GDP in 2024. These patterns weaken “inflation expectations” and the wage-price-spiral narrative. This is another reason to reserve the policy rate for core inflation while using non-rate tools for headline shocks.</p>.<p>Several central banks have recently acknowledged the limitations of the inflation-targeting framework. The inflation-growth nexus is non-linear, and the RBI’s concern to control inflation is understandable. A more balanced framework requires protecting both price and livelihood stability, rather than trading one off against the other. Before the neoliberal era, the RBI routinely used quantitative and selective credit controls to stabilise essential sectors. RBI can retain the 4±2 framework for credibility but supplement it with selective credit controls to stabilise essential sectors.</p>.<p>Price control measures and fiscal policy interventions are crucial for managing the prices of essential commodities. During the COVID-19 pandemic, stock-limit orders, buffer releases, and subsidised retail helped contain price spikes. Formalising these tools and reinforcing them with MSME support and competition policy would improve pass-through to consumers. Stronger regulatory oversight and sector-specific measures can discourage opportunistic markup expansion and promote fair pricing. Given India’s diverse economy, inflation necessitates coordinated action among monetary and fiscal authorities, as well as local administrative levels. Recognising structural realities would allow monetary policy to focus more effectively on core inflation, while coordinated supply and direct price control measures manage non-core volatility. Monetary policy must support the economy’s long-term transition towards higher productivity and improved living standards.</p>.<p><em>(The writer teaches economics at IIT Kharagpur)</em></p> <p><em>Disclaimer: The views expressed above are the author's own. They do not necessarily reflect the views of DH.</em></p>
<p>By March 2026, India must decide whether to retain or modify the inflation targeting (IT) regime, which has been guided by a 4% Consumer Price Index (CPI) inflation target with a ±2% band since the 2016 amendment to the Reserve Bank of India (RBI) Act. The review will revisit familiar questions: Should the target remain at 4%? Should policy focus on headline or core inflation? Should the tolerance band be revised? While these questions are important, they overlook the core challenge. In an economy where supply shocks, bottlenecks, sectoral imbalances, and mark-up pricing alongside stagnant wages drive much of the volatility, the policy rate alone cannot shoulder the burden of price stabilisation. The review risks remaining inside the very frame that produces the trade-offs; it is the design of the framework, not just the settings, that deserves scrutiny.</p>.<p>While the IT framework has helped avoid persistent inflation, the 4% midpoint has not operated as a strong anchor, as inflation remained above 4% in most years, even if within the 6% tolerance band. The 6% tolerance band was breached in 2020-21 and 2022-23. This mixed evidence suggests credibility at the band level, but not at the midpoint. However, part of the difficulty lies not in policy calibration but in deeper structural changes in the economy. In the post-reforms era, services have grown faster and now account for a disproportionate share of income relative to output. This has created a structural imbalance, where incomes have grown faster in services while output growth in commodity-producing sectors has lagged, contributing to price pressures that are not responsive to IT. Hence, the IT review must go beyond the neoliberal policy frame and consider how monetary policy adapts to a changing global economic order and multipolar world.</p>.<p>Food, fuel, and other essential commodity prices, which drive headline inflation, respond to supply-side factors such as weather, global commodity cycles, geopolitical disruptions, import pass-through, supply chain inefficiencies, hoarding, and anti-competitive practices. Interest rate-based monetary policy cannot meaningfully contain such inflation.</p>.<p>Advocates of anchoring headline inflation raise concern that food inflation may feed into a wage-price spiral. However, the evidence shows wages have grown more slowly than GDP between 2014 and 2025, reflecting a pattern of long-term wage stagnation. Using interest rates to contain headline inflation, therefore, suppresses consumption without addressing the underlying causes of price increases. National Sample Survey Office (NSSO) data indicate that household consumption has grown significantly more slowly than GDP between 2011 and 2023, indicating a disproportional burden on the disadvantaged. Additionally, climate-related shocks have increased volatility in these components, and the current IT framework cannot manage them.</p>.<p>The difficulty is not inflation per se, but an IT framework that reduces stabilisation to a single lever, the repo rate, regardless of the source of inflation. In such a design, high rates often choke investments the economy needs in manufacturing and agriculture, while EMIs rise for the middle and upper-middle classes. Livelihood costs rise while the sources of inflation that are not rate-sensitive remain largely untouched. Over the past decade, growth has been uneven, with aggregate saving and investment hovering at around 30% of GDP, while manufacturing and agricultural output have grown modestly.</p>.<p>Additionally, the effectiveness of monetary policy is weakened due to segmented credit markets and frictions. The large, promoter-controlled, group-affiliated, and listed corporate groups are relatively insulated from policy tightening due to their market power and diversified financing options. In contrast, pass-through to medium, small, and micro enterprises (MSMEs) and households is partial and slow. Thus, tightening hurts more than easing helps.</p>.<p><strong>Profit-linked inflation</strong></p>.<p>Profit-linked inflation remains overlooked in mainstream debates in India. Evidence from advanced and emerging markets shows profits have accounted for a share of price increase, especially in concentrated markets where firms possess the power to set prices and can use supply shocks or cost volatility to expand mark-ups rather than merely pass on costs. In India, Motilal Oswal reports that the corporate profit-to-GDP ratio (4.7%) is now at a 17-year high.</p>.<p>Labour costs did not drive this episode. FICCI-Quess Corp finds compounded annual wage growth of 0.8% in engineering/manufacturing/ infrastructure, rising to 5.4% in FMCG. During the pandemic recovery, large firms deleveraged, improving their balance sheets. Household purchasing power lagged, and household debt stood at about 42% of GDP in 2024. These patterns weaken “inflation expectations” and the wage-price-spiral narrative. This is another reason to reserve the policy rate for core inflation while using non-rate tools for headline shocks.</p>.<p>Several central banks have recently acknowledged the limitations of the inflation-targeting framework. The inflation-growth nexus is non-linear, and the RBI’s concern to control inflation is understandable. A more balanced framework requires protecting both price and livelihood stability, rather than trading one off against the other. Before the neoliberal era, the RBI routinely used quantitative and selective credit controls to stabilise essential sectors. RBI can retain the 4±2 framework for credibility but supplement it with selective credit controls to stabilise essential sectors.</p>.<p>Price control measures and fiscal policy interventions are crucial for managing the prices of essential commodities. During the COVID-19 pandemic, stock-limit orders, buffer releases, and subsidised retail helped contain price spikes. Formalising these tools and reinforcing them with MSME support and competition policy would improve pass-through to consumers. Stronger regulatory oversight and sector-specific measures can discourage opportunistic markup expansion and promote fair pricing. Given India’s diverse economy, inflation necessitates coordinated action among monetary and fiscal authorities, as well as local administrative levels. Recognising structural realities would allow monetary policy to focus more effectively on core inflation, while coordinated supply and direct price control measures manage non-core volatility. Monetary policy must support the economy’s long-term transition towards higher productivity and improved living standards.</p>.<p><em>(The writer teaches economics at IIT Kharagpur)</em></p> <p><em>Disclaimer: The views expressed above are the author's own. They do not necessarily reflect the views of DH.</em></p>
