The Reserve Bank of India (RBI) in 2025 released a discussion paper on its monetary policy framework. It cautioned against raising the inflation target, warning that this might undermine the credibility gained over the past decade. The paper invites public feedback on key aspects of inflation targeting, as the current framework is due for review in 2026.
Background of Inflation Targeting in India
India formally adopted flexible inflation targeting in late 2016. The framework sets a medium-term inflation target of 4 per cent based on the Consumer Price Index (CPI), with a tolerance band of 2 to 6 per cent. The target is reviewed every five years in consultation with the government. The current target is valid until March 2026, after which it must be re-notified or revised.
Key Questions Raised by RBI
The discussion paper asks four main questions – whether the RBI should target headline or core inflation; if the 4 per cent target remains optimal; whether the tolerance band should be revised or removed; and if the target rate should be replaced by a range only. The RBI stresses that changing the target now could be seen as weakening the framework, especially amid global economic uncertainties.
Headline vs Core Inflation Debate
Headline inflation includes volatile food and fuel prices, while core inflation excludes them. The Economic Survey 2023-24 suggested exploring targeting inflation excluding food due to its large CPI weight and supply-driven price shocks. However, RBI maintains that food inflation cannot be ignored as it influences core inflation through wage and cost pressures. Most countries target headline inflation, with Uganda as a rare exception targeting core inflation.
Inflation Trends and Policy Implications
Headline retail inflation hit a low of 1.55 per cent in July 2025, its second-lowest since the current CPI series began. Food inflation has shown high volatility, ranging from -2.7 to 14.2 per cent since 2014, while core inflation remained more stable. The RBI emphasises the importance of policy certainty and credibility, especially in uncertain global conditions, advocating for continuity in the tested inflation targeting framework.
Global and Domestic Impact
Stable inflation is key to attracting foreign investment and maintaining economic growth. Sharp inflation spikes can erode investment value, weaken the currency, and cause social unrest. The RBI’s cautious approach aims to preserve institutional credibility and fiscal responsibility, which have contributed to India’s improved sovereign rating by agencies like S&P Global Ratings.
Future Outlook
The RBI has invited public comments by 18 September 2025 to help shape the policy framework for the next five years. The final decision will rest with the government, guided by the RBI’s recommendations. This review will influence India’s monetary policy stance amid geopolitical uncertainties and evolving economic challenges.
Questions for UPSC:
- Discuss the significance of inflation targeting in monetary policy. How does it impact economic growth and financial stability?
- Critically examine the challenges of targeting headline inflation versus core inflation in emerging economies like India.
- Explain the role of central banks in maintaining policy credibility during times of global economic uncertainty. With suitable examples, discuss how this affects foreign investment.
- Comment on the relationship between inflation, currency stability, and social unrest. How can monetary policy mitigate these risks?
