RBI at fork in the road, experts back chasing headline inflation

A day after the Reserve Bank of India (RBI) reignited the debate over its inflation-targeting framework, a wide array of analysts argued that anchoring monetary policy to headline inflation remains the most effective approach for the country.

The primary argument for maintaining the status quo is the simple reality of the Indian consumer. Food accounts for a staggering 46% of India’s consumer price index (CPI) basket, the highest weighting among 46 nations that use inflation targeting. For the average Indian household, especially in lower-income brackets, food costs are a disproportionately large portion of their budget.

“You cannot create an easy financial environment when one side of your consumption basket is seeing upward pressure,” said Gaura Sengupta, chief economist at IDFC First Bank. Sengupta believes it makes sense to target headline inflation, and from the RBI paper, it looks like it will be retained as the anchor.

Global preference

In a discussion paper on Thursday, the RBI said headline inflation is preferred globally as a more representative measure of overall price conditions. In fact, except for Uganda, all nations that target inflation track headline inflation to set monetary policy.

Under the flexible inflation targeting framework introduced in 2016, the central bank strives to achieve a headline inflation rate of 4%, with a flexibility of 2% on either side of the target. Headline inflation includes food prices, though they are largely out of the central bank’s control. Core inflation, which strips out food and energy prices, can be useful tool to gauge demand in the economy, but experts say it wouldn’t reflect the full picture of what most people experience in their daily lives.

The current policy on inflation targeting ends in March 2026.

“The simple reason why it should be headline and not core is that what affects the economy is the headline and not any particular segment,” said Madan Sabnavis, chief economist, Bank of Baroda.

According to Sabnavis, inflation targeting is also about how everybody is affected by that inflation number. If the monetary policy committee looks only at core inflation, it will be limited in scope, he said. Sabnavis added that the inflation target should be revised from 4% since average inflation over the last 15 years is closer to 5%. However, he favours removing the flexible band plus or minus 2% at present — or at least narrowing the corridor.

Cooling inflation

India’s retail inflation stood at 1.55% in July, the softest since June 2017. Thursday’s discussion paper said that, like other countries, India may consider narrowing its current tolerance band to about 1-1.5%.

While a few economists suggested potential adjustments, such as narrowing the existing 2% tolerance band or raising the 4% inflation target, they cautioned against abandoning the current framework.

Apart from which inflation to track, RBI’s paper also posed certain other questions. These were around the inflation target of 4%, and the tolerance band that allows the rate-setting committee some flexibility even when inflation overshoots the 4% target. In 2022, the MPC failed to meet the flexible target of 2-6% for three straight quarters between January and September, compelling it to apprise the government about the reasons for its failure and remedial measures.

“There could be some practical tweaks without moving the 4% anchor,” said Madhavi Arora, chief economist, Emkay Global Financial Services Ltd.

Arora said policymakers may keep 4% as the midpoint, but allow explicit, data-contingent timelines for returning to target after supply shocks. They may have so-called dual-lens operations — Targeting headline inflation; using core inflation to calibrate persistence and stance, and communicate both explicitly, said Arora.

Food weight

On the headline-core inflation debate, Arora said that for India, given the high food weight — likely to be revised lower by February 2026 — and repeated persistence of food shocks, there is still a case that headline inflation remains the primary anchor of monetary policy. “But core inflation should guide tactical decisions or be seen as an operational guide on how forcefully and persistently the RBI reacts, since it reflects demand-driven pressures,” she added.

Rising food prices have a significant impact on India’s poorest households. According to a government survey, over 90% of the lowest rung of rural families, ranked on the basis of per capita expenditure, and 50% of the equivalent set of urban families spend more than half of their monthly budget on food and energy.

According to Kanika Pasricha, chief economic advisor, Union Bank of India, continued focus on headline inflation is key, since food has a significant impact on the inflation expectations in the economy. “That said, with the CPI basket under revision from February 2026, it is likely to include a lower share of food aligned with the latest expenditure surveys, and also aligned to a similar research by Dr Poonam Gupta and Barry Eichengreen.”

Target chase

Raising the inflation target at this stage, when the global economy is confronted with geopolitical uncertainty and geo-economic fragmentation, may be seen by global investors as diluting the inflation targeting framework, undermining policy credibility.

“Removing the 4% target while retaining the 2-6% band would be impractical, as by default one tends to associate the midpoint as an anchor in economic decision-making,” said Vivek Kumar, economist at QuantEco Research, an independent economic advisory services firm.

Kumar said that while one could argue in favour of having just a target band amid the current state of heightened global uncertainties, the flip side is that it could potentially weaken the policy resolve for inflation discipline, especially under conditions of fiscal dominance.

Like his peers, Kumar also believes that headline inflation is the right metric to track for monetary policy. He said that since headline inflation is easily comprehensible by the private and household sectors, its choice as a target becomes important for transmitting clear policy signals. Having said that, while headline inflation could be a superior choice for targeting in an emerging market economy, policymakers cannot disregard core inflation, he added.