For the next five years, the present inflation target of 2 to 6 per cent is appropriate, stated Reserve Bank of India in its report on currency and finance (RCF) for the year 2020-21.
The report stated, “The current numerical framework for defining price stability, i.e., an inflation target of 4 per cent with a +/-2 per cent tolerance band, is appropriate for the next five years.” While the RBI report states that the present inflation is appropriate for India, there are other emerging market economies (EMEs) that have generally lowered their inflation targets and narrowed tolerance bands.
Inflation above 5 and 6 per cent in India hinders growth, the report suggested. Thus, indicating that an inflation rate of 6 per cent is the appropriate upper tolerance limit for the inflation target. “On the other hand, a lower bound above 2 per cent can lead to actual inflation frequently dipping below the tolerance band while a lower bound below 2 per cent will hamper growth, indicating that an inflation rate of 2 per cent is the appropriate lower tolerance bound.”
During 2020-2021, the headline CPI inflation averaged 3.9 per cent in India with a decline in inflation volatility,
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. However, it excludes the period of the COVID-19 pandemic in view of data distortions.
The report stated, “Trend inflation to which actual inflation converges after a shock provides an appropriate benchmark for the inflation target; trend inflation has fallen from above 9 per cent before FIT to a range of 3.8 – 4.3 per cent during FIT, indicating that 4 per cent is the appropriate level of the inflation target for India.