Inflation is an economic concept defined as a sustained increase in the general price level of goods and services, measured as an annual percentage increase, which reflects a reduction in the purchasing power of money. Historically, India experienced high inflation volatility, with average inflation around 7.5% since the 1980s, necessitating a strong nominal anchor. The formal shift to a rule-based system began with the Monetary Policy Framework Agreement (MPFA) between the Government and the Reserve Bank of India (RBI) in February 2015. This was given statutory backing by an amendment to the Reserve Bank of India Act, 1934 in May 2016, establishing the Flexible Inflation Targeting (FIT) regime.
The mechanism is governed by the RBI Act, 1934, which mandates the RBI to maintain price stability. Under Section 45-ZA, the government, in consultation with the RBI, sets the inflation target every five years. The current target is 4% for the Consumer Price Index (CPI)-Combined, with a tolerance band of +/- 2% (between 2% and 6%). The CPI is the official measure, having replaced the Wholesale Price Index (WPI) in 2013. The Monetary Policy Committee (MPC), a six-member body constituted under Section 45ZB of the RBI Act, 1934, is responsible for setting the policy interest rate to achieve this goal. Failure occurs if inflation is outside the 2% to 6% band for three consecutive quarters. Recently, the government retained the 4% target and +/- 2% band for the period from April 1, 2026, to March 31, 2031, marking the second consecutive extension of the framework.