RBI Reviews Inflation Framework, Considers Narrower Price Band

The Reserve Bank of India (RBI) has initiated a review of the monetary policy framework as the current five-year mandate ends in March 2026. A provision in the Reserve Bank of India Act, 1934, mandates a review every five years with the central government.

The existing framework, adopted in 2016, mandates a four per cent consumer price index (CPI) inflation target with a tolerance band of plus or minus two per cent. This tolerance band was maintained in the first review in 2021. RBI questioned in the latest discussion paper issued in August 2025 whether the tolerance band should be reduced, increased, or eliminated.

Performance Of Inflation Targeting

Since the adoption of flexible inflation targeting in 2016, average inflation has been 4.9 per cent, compared to 6.8 per cent in the pre-framework period. In the initial years, inflation remained close to four per cent, but it breached the six per cent upper tolerance during the pandemic and again after the Russia–Ukraine conflict.

From the fourth quarter of 2021–22 to the fourth quarter of 2022–23, inflation was more than six per cent for five straight quarters, reaching a high of 7.8 per cent in April 2022. According to the law, the RBI had to file a report with the central government regarding the violation.

Inflation eased since then, with support from supply-side measures and softening global commodity prices. As of the first quarter of 2025–26, CPI inflation was modestly below four per cent.

Headline Or Core

The review also examines whether headline inflation or core inflation should guide monetary policy. Headline CPI includes all items, while core CPI excludes food and fuel.

Food and fuel account for nearly half of India’s consumption basket. The latest Household Consumption Expenditure Survey for 2023–24 shows that 90 per cent of the lowest rural households and 50 per cent of the lowest urban households spend more than half of their consumption on food and energy.

RBI’s 2014 expert committee had recommended headline inflation as the target measure, citing the weight of food and fuel in consumption, their role in inflation expectations, and their importance in household cost of living.

The Four Per Cent Target

The four per cent CPI inflation target has been in place since 2016. Trend inflation estimates, which indicate the underlying level of inflation, also place it close to four per cent.

Internationally, advanced economies mostly target around 2 per cent, while emerging market economies generally aim for 3 to 6 per cent. Several emerging markets have gradually lowered their targets over time as inflation expectations stabilised.

For India, empirical studies, including those revisited by RBI staff, indicate that 4 per cent remains the level consistent with stable growth and minimal output gap.

Tolerance Band Debate

The current tolerance band of two to six per cent provides flexibility to accommodate shocks. RBI’s discussion paper asks whether this band should be narrowed, widened, or removed in favour of a range-only target.

Analysis shows that while inflation volatility has reduced since the framework was adopted, food inflation remains more volatile than core inflation. Persistent food inflation can spill over to core prices through wages and rents, creating second-round effects.

International comparisons show that many emerging economies maintain narrower bands of plus or minus one per cent, while India’s band is wider.

RBI has invited public feedback on the discussion paper until 18 September 2025. The final target, bank of tolerance, and framework for the next five years will be notified prior to April 2026. The responses will inform its recommendations to the central government.