India's flexible inflation targeting framework faces its sternest test when supply-side shocks push CPI beyond the tolerance band. Critically examine the effectiveness of repo rate hikes in such situations.

Under Flexible Inflation Targeting (FIT), the RBI aims to hold CPI inflation at 4% within a ±2% band while supporting growth [2]. In October 2026, CPI rose to 6.09%, above the band's upper limit, and markets began to expect a repo hike [1]. When the cause is a supply shock, a hike is needed, but it cannot do the job alone.

Effectiveness of repo hikes

• Anchoring expectations: If inflation stays above 6%, workers ask for higher wages and firms raise prices in advance. A timely hike stops a food shock from spreading to all prices. An RBI study found that CPI volatility fell under FIT despite repeated supply shocks [3].
• Credibility and signalling: The RBI had already shifted to "calibrated tightening" after a 25 bps hike to 5.50% [6]. Markets priced in a further hike before any decision, and the Sensex fell on rate fears [1]. This shows forward guidance works.
• Faster transmission: Since October 2019, EBLR-linked loans and money-market rates follow the repo rate quickly [5]. This curbs demand-side spillovers.

Limitations

• Cannot cure supply: A hike cannot grow vegetables or lower crude prices. Food's high CPI weight keeps headline inflation swinging with the monsoon and global events [3][4].
• Growth cost and asymmetry: Borrowers face higher EMIs first, especially MSMEs and floating-rate home-loan holders. Deposit rates rise more slowly during tightening [5].
• Distributional burden: Poor households already hit by food prices then also face slower job and credit growth.
• Framework debate: The RBI's 2025 discussion paper itself asked whether to target headline or core CPI, given food's large weight [4].

Way forward

• Look through first-round shocks; act on second-round effects. Track core inflation and household expectations before tightening.
• Fiscal–monetary coordination: Releasing buffer stocks, rationalising taxes and using calibrated trade measures help keep prices stable [3].
• Structural supply reforms: Cold chains, warehousing and crop diversification.

Repo hikes do not fix supply shocks, but they still anchor expectations and protect the credibility of FIT. They work best when paired with government action on supply. That combination keeps inflation inside the band and gives the stability that sustained, inclusive growth needs, as the RBI Act's price-stability-with-growth mandate intends.