RBI to Review Monetary Policy Framework Amid Changing Inflation Dynamics

The Reserve Bank of India (RBI) has announced that it will undertake a review of the monetary policy framework during the financial year 2025-26, alongside evaluating the optimal liquidity level needed to ensure effective monetary policy transmission. This forms part of the RBI’s broader strategic outlook as inflationary pressures, financial market dynamics, and economic conditions evolve.

Why in News?

The RBI’s Annual Report 2024–25 highlights two crucial policy priorities for FY26. Review of the monetary policy framework, particularly the inflation targeting mechanism. Assessment of systemic liquidity requirements for efficient policy rate transmission. This comes amid suggestions from the Economic Survey and economists that core inflation (excluding food and fuel) may be a more stable target due to volatility in food prices.

Key Highlights

• The current inflation target is 4% with a tolerance band of ±2%, in effect till March 31, 2026.
• The RBI may consider shifting focus to core inflation to improve policy responsiveness.
• The External Benchmark Linked Rate (EBLR) regime has strengthened policy transmission.
• RBI targets maintaining system liquidity at 1% surplus of Net Demand and Time Liabilities (NDTL).
• As of May 2025, liquidity stands at ₹1.91 trillion, about 0.7% of NDTL.
• Background
• Under the current flexible inflation targeting (FIT) framework, the RBI is mandated to keep CPI inflation at 4%.
• The target was last renewed in 2021 for five years in consultation with the Government of India.
• Monetary transmission refers to how policy rate changes (like repo rate) impact market interest rates.

Objectives of the Review

• Reassess the appropriateness of headline CPI as the primary inflation indicator.
• Ensure that the monetary policy remains effective amid high food price volatility.
• Evaluate the liquidity level necessary to support the monetary policy stance during the easing cycle.

Significance

• Strengthening the framework can enhance financial stability.
• Improved transmission ensures faster impact of policy changes on borrowing/lending rates.
• Fine-tuning liquidity will support credit growth and economic expansion.