RBI to target core inflation: Even as the global economy grapples with uncertainty, the Reserve Bank of India has demonstrated a steady hand—managing to replenish government coffers while maintaining a cautious but flexible monetary stance. Its recently released Annual Report for FY25 outlines a pragmatic strategy for FY26, with a focus on preserving financial stability and recalibrating policy tools to suit a shifting global and domestic economic terrain.
At the centre of its agenda is the review of the monetary policy framework—arguably one of the most consequential exercises for the upcoming fiscal year. Since March 2021, India has adopted a flexible inflation targeting regime, aiming to keep headline Consumer Price Index (CPI) inflation at 4%, with a tolerance band of +/- 2%. However, calls are growing—from the Economic Survey among others—for a shift toward targeting core inflation, which excludes volatile food and fuel prices.
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Food and energy prices can fluctuate significantly due to factors like weather, global supply chains, and geopolitical events, which can mask the true trend of inflation. Instead, core inflation includes the prices of goods and services that are more stable such as the costs of housing, transportation (excluding fuel), and services like education and healthcare.
A framework under review
The case for reform is rooted in the structural limitations of monetary policy. Food inflation in India is frequently driven by supply-side disruptions such as erratic monsoons or export restrictions—factors that interest rate adjustments are ill-equipped to address. Economists argue that a focus on core inflation would provide a more accurate gauge of demand-side pressures, and in turn, improve policy responses. That the RBI is open to reassessing the very framework it has followed for years reflects a commendable willingness to adapt to evolving macroeconomic realities.
Alongside the inflation targeting review, the central bank is also reassessing the ideal level of liquidity in the banking system—an essential lever for effective monetary transmission. The Annual Report underscores the RBI’s growing emphasis on the efficacy of its policy signals, particularly under the External Benchmark Linked Rate (EBLR) regime. This system, which links a greater share of loans to external benchmarks rather than banks’ internal Marginal Cost of Funds Based Lending Rates (MCLR), has sharpened the pace and precision of monetary transmission.
Transmission and liquidity: A tactical shift
RBI Governor Sanjay Malhotra has signalled that the central bank will aim to maintain a modest liquidity surplus—around 1% of banks’ net demand and time liabilities. This marks a strategic shift from earlier deficit-oriented stances, and reflects a more proactive approach to policy steering, especially in a period marked by external volatility and tightening global financial conditions.
Perhaps the most headline-grabbing figure in the report is the central bank’s record surplus transfer of Rs 2.69 lakh crore to the government—the highest ever, and 27% higher than the previous year. This windfall, fuelled by higher interest income from domestic and overseas assets, robust gains from forex revaluation, and prudent investment management, underscores the RBI’s sound financial stewardship. While the cost of currency printing rose marginally, total expenditure was tightly controlled, rising only 8%.
Importantly, the central bank did not exhaust its surplus. Instead, it significantly bolstered its Contingency Fund by Rs 1.13 lakh crore—a prudent move as the economy enters uncertain terrain. Buffers such as these will be critical, particularly if external shocks, fiscal slippage, or financial stress arise in the months ahead.
While the macroeconomic outlook remains broadly positive, the road ahead is uneven. Real GDP growth for FY25 stood at 6.5%, reaffirming India’s position as one of the fastest-growing major economies. Rural consumption is recovering, aided by a favourable monsoon and higher minimum support prices. Exports have also outpaced imports, contributing to a modest current account cushion. But headwinds persist. Government spending has moderated, investment momentum—especially from foreign investors—has slowed, and industrial activity has faltered, as reflected in the latest Index of Industrial Production (IIP) data.
Yet, there are bright spots. Labour force participation and employment ratios have reached record highs. Headline inflation has eased to 4.6%. Agriculture and allied sectors are showing resilience. These indicators offer hope that domestic demand will remain sturdy, even if global shocks grow more frequent.
Resilience amid global turbulence
On the external front, however, risks abound. A finance ministry report has already flagged concerns over a potential wave of protectionist measures, including the reimposition of Trump-era tariffs. Global growth is projected to decelerate to 2.8% in 2025 and 3.0% in 2026, down from 3.3% in 2024. Mounting public debt, persistent geopolitical tensions, supply chain realignments, and climate disruptions are all weighing heavily on the outlook.
In this climate, the RBI’s strategy for FY26 will be vital to sustaining India’s macroeconomic stability. Its twin focus—revisiting the inflation targeting framework and managing system liquidity with precision—reflects both strategic foresight and institutional maturity. The central bank may not be able to shield India from every global tremor, but its recent moves show it is intent on ensuring the domestic foundations remain firm.