Despite headline retail inflation falling below RBI's lower comfort band of 2%, core inflation in India has surged to multi-year highs. Analyse the implications of this divergence for monetary policy and growth.

CPI inflation stood at 1.33% in December 2025, well below the 2% lower tolerance bound of the flexible inflation targeting (FIT) framework, even as core inflation (CPI excluding food and fuel) touched a 28-month high of about 4.8% [1][3]. This divergence signals that headline softness is supply- and base-effect driven, not a collapse in demand.

Decomposing the divergence

• Food deflation is the sole anchor: the Consumer Food Price Index contracted –2.71% in December 2025, against food inflation of about 7.7% a year earlier — a statistical base effect that will fade [1][3].
• Core is firm: housing (2.86%) and services-linked components remain positive, reflecting resilient urban demand [3].
• Growth is not weak: real GDP grew 8.2% in Q2:2025-26, a six-quarter high on robust domestic demand — inconsistent with a deflationary slump [2].

Implications for monetary policy

• The MPC's mandate under Sections 45ZA–45ZB, RBI Act, 1934 is CPI-headline-based; a breach below 2% for three consecutive quarters triggers a failure report to the Centre, an accountability test the framework has not faced from the downside [4].
• Headline undershooting justified the repo rate cut to 5.25% in December 2025 with a neutral stance — preserving optionality precisely because core is sticky [2].
• Sticky core limits further easing: cutting aggressively on a base-effect-driven number risks importing inflation once food prices normalise.

Implications for growth

• Lower rates ease borrowing costs and support credit, investment and consumption.
• However, food deflation compresses farm realisations and rural nominal incomes, weakening rural demand and widening the rural–urban gap.
• Firm core inflation erodes real wages of low-income households, who spend heavily on housing and essentials.

The divergence therefore calls for policy that looks through transient food swings while anchoring expectations on core. Retention of the 4% ± 2% target for 2026–31 [4], combined with supply-side reforms in agricultural marketing, storage and logistics, offers the durable route to price stability with growth — fulfilling the FIT mandate of "price stability, keeping in mind the objective of growth".