Inflation, interest rates and the Reserve Bank

Inflation is a sustained rise in the general price level, which reduces what money can buy. India tracks it mainly through the Consumer Price Index (CPI), which measures retail prices of a basket of goods and services, and the Wholesale Price Index (WPI), which measures prices at the wholesale stage. The two can move apart: food and fuel prices, which weigh heavily in household budgets, affect CPI more directly, while global commodity prices show up faster in WPI. For ordinary households, CPI inflation is the more relevant measure, and it is the one the Reserve Bank now targets.

The Reserve Bank of India (RBI), set up in 1935 and nationalised in 1949, is the central bank: it issues currency, regulates banks, manages the government's borrowing and the exchange rate, and conducts monetary policy. Since 2016, monetary policy has followed a flexible inflation targeting framework, adopted by amending the RBI Act, 1934. The government and the RBI set a CPI inflation target of 4 per cent, with a tolerance band of plus or minus 2 percentage points, so inflation between 2 and 6 per cent is within the band. The target is reviewed every five years.

The policy rate is set by the Monetary Policy Committee (MPC), a six-member body created in 2016 with three members from the RBI, including the Governor as chair, and three external members appointed by the government. Its main tool is the repo rate, the rate at which the RBI lends to banks. Raising the repo rate makes borrowing dearer and is meant to cool demand and prices; cutting it is meant to support growth. The trade-off is real: fighting inflation too hard can slow jobs and investment, while tolerating it too long erodes savings and hits the poor hardest, since food takes a larger share of poor households' spending.

Inflation targeting has supporters and critics. Supporters say a public target disciplines policy and anchors expectations. Critics say food price shocks, driven by monsoon and global prices, cannot be fixed by interest rates, and that the framework can put growth second. Either way, the framework changed Indian monetary policy from a discretionary, multiple-indicator approach to a transparent, target-based one — and every rate decision is now argued in public against a single number.