Flexible Inflation Targeting (FIT) –  UPSC 2026

---

🔥 SECTION A — MUST-KNOW BASICS (UPSC LOVES FACTS)

1. Legal Backing

FIT is implemented under Section 45ZA of RBI Act, 1934 (amended in 2016).

2. Inflation Target

• 4% CPI headline inflation

• With ±2% band → 2%–6%

3. Who Sets the Target?

• Government of India

• In consultation with RBI

4. Institutional Mechanism

• MPC (Monetary Policy Committee)
  Composition (6 members):

  • RBI Governor (Chair)

  • RBI Deputy Governor (Monetary Policy)

  • One RBI official

  • 3 external members appointed by Government

5. Failure Clause (VERY IMPORTANT)

RBI fails if:

• Inflation >6% for 3 consecutive quarters, or

• Inflation <2% for 3 consecutive quarters

➡ RBI must write a letter to Govt explaining WHY and HOW it will correct.

---

🔥 SECTION B — WHY THE FRAMEWORK IS UNDER REVIEW (Ending March 2026)

• Current target period: 2016–2021, extended to 2021–2026

• Ends: March 31, 2026

• RBI released a Discussion Paper (2024) asking for views on:

  1. Headline vs Core

  2. Acceptable level of inflation

  3. Appropriate tolerance band

---

🔥 SECTION C — EXAM-FOCUSED CONCEPTS

✔ 1. Headline vs Core Inflation — Most Probable Prelims Q

Why Headline Should Be Targeted

• Reflects actual cost of living

• Impacts poor households most

• Food inflation has second-round effects → wages, services, core inflation

• Food inflation is NOT purely supply-driven → can spike due to easy money

➡ UPSC Keyword:

“Food inflation spills into core inflation in India.”

Why Not Core?

• Excludes food & fuel (unrealistic in India)

• Not reflective of majority household consumption

➡ Correct target: HEADLINE CPI (confirmed by RBI DP)

---

✔ 2. Acceptable Level of Inflation (Threshold Inflation Theory)

Empirical Finding

• Using 1991–present data:
  Threshold ≈ 3.98%

• Growth begins to fall sharply above 4%

UPSC Trick Insight

➡ Target should NOT be raised above 4%.

Forward-Looking

• Simulations (2026–2031): optimal inflation below 4%.

---

✔ 3. Appropriateness of the ±2% Band

Why Current Band Should Continue

• Helped navigate:

  • COVID-19 supply shock

  • Russia–Ukraine war inflation

  • Food shocks

  • Crude volatility

• Narrower bands globally used by advanced economies—not suitable for India.

But Warning:

• Staying too long near upper band (5–6%) undermines credibility

• No rule prescribing how long RBI can stay near 6%

➡ UPSC Keyword:

“Upper-band drift problem in FIT.”

---

✔ 4. Link Between FIT and FRBM — Most Ignored by Aspirants

RBI cannot control inflation if fiscal deficit is monetised.

Historically:

• 1970s–80s inflation = automatic monetisation of Govt deficit

• Reforms:

  • 1994: End of ad hoc treasury bills

  • 2003: FRBM Act

  • 2016: FIT

➡ UPSC loves this line:

“FRBM and FIT must function together. Weakening one undermines the other.”

---

✔ 5. Milton Friedman’s Insight (UPSC Favourite)

Relative price changes ≠ Inflation.

General price level rises only when money supply expands.

➡ UPSC Keyword:

“General price level cannot rise without monetary accommodation.”

---

🔥 SECTION D — MOST LIKELY PRELIMS QUESTIONS (2026)

Q1. Consider the following:

1. FRBM

2. Flexible Inflation Targeting

3. Market Stabilisation Scheme

4. Monetary Policy Framework Agreement

Which of the above have a direct role in anchoring inflation expectations?

Answer: 1, 2 and 4

---

Q2. Which inflation measure does India target under FIT?

A. Core CPI

B. Wholesale Price Index

C. Headline CPI

D. CPI excluding food & fuel

Answer: C

---

Q3. FIT framework fails when inflation:

A. Exceeds 5% for any 2 months

B. Exceeds 6% for three quarters

C. Exceeds 6% for three months

D. Stays below 2% for two quarters

Answer: B

---

Q4. Which of the following increases the risk of inflation under FIT?

1. Fiscal dominance

2. Monetisation of deficit

3. Persistent food-price shocks

4. Easy money policy

Answer: 1, 2 and 4

---

Q5. ‘Threshold Inflation’ refers to:

A. Minimum inflation required for industrialisation

B. Inflation level after which growth declines

C. Inflation needed to meet fiscal goals

D. RBI’s comfort inflation level

Answer: B

---

🔥 Final Takeaways (Prelims GOLD POINTS)

• Target must remain headline CPI

• Threshold inflation ≈ 3.98%

• Band 2–6% should stay

• FIT success = requires fiscal discipline

• Food inflation is NOT outside monetary policy

• Core inflation target is unsuitable for India

• Upper-band drift weakens credibility

• FIT & FRBM are joint pillars of macro stability