Font size:
Print
Food Inflation in Inflation Targeting of RBI
Context:
Recently in an interview Viral Acharya, former RBI deputy governor, explains the importance of including food inflation in the inflation targeting framework.
Food Inflation in India
Retail Food Inflation Trends:
-
-
- Food inflation spiked in 2020 due to supply chain disruptions but eased in 2021 with improved supply measures.
-
-
-
- CPI (45.9% weight in food) is more sensitive to food price changes than WPI (24.4% weight).
-
Pandemic and Demand Impact:
-
-
- The COVID-19 pandemic and pent-up demand initially caused inflationary pressures.
- Current inflation drivers include the Russia-Ukraine conflict, excessive heat, and uneven rainfall distribution.
-
Inflation Control Measures:
-
-
- Inflation remained manageable due to administrative measures and monetary tightening, including policy repo rate hikes after the Russia-Ukraine conflict.
- While core inflation stayed low, headline inflation remained high due to rising food prices and the El-Nino effect.
-
Current Outlook on Interest Rates of RBI:
-
-
- The Reserve Bank of India (RBI) is closely monitoring trends in food inflation. Rate adjustments may be considered if food inflation decreases.
- The RBI remains focused on maintaining its 4% inflation target while evaluating whether the current softness in economic growth is temporary or indicative of longer-term issues.
-
Reasons to Include Food Inflation in Monetary Policy Targeting:
- Influence on Inflation Expectations
-
-
- Food inflation significantly shapes household and investor inflation expectations.
- Rising food prices lead to higher wage demands, which can trigger wage inflation and affect core inflation.
-
- Impact on Core Inflation
-
-
- Ignoring food inflation can result in increased inflation expectations, driving overall inflation higher.
- Managing both core and food inflation helps stabilise expectations and maintain lower borrowing costs.
- According to Economic Survey 2023-24 while India’s Core inflation has been under control driven by RBI repo rate hike, food inflation remains high.
-
- Exclusion of food inflation targeting can lead to spill over impact on core inflation leading to higher headline inflation.
- Wage Inflation and Price Generalization
-
-
- High food inflation prompts households to expect higher future prices, pushing workers to demand wage increases.
- This can spread inflation from essentials like food and fuel to the broader economy, generalising price increases.
-
- Effect on Lower-Income Households
-
-
- Food inflation disproportionately affects lower-income households, who are more sensitive to real income changes.
- Excluding food inflation neglects these pressures, potentially worsening inflation expectations and reducing consumption, which could lead to stagflation.
-
Arguments for Excluding Food Inflation from Inflation Targeting
- Volatility of Food Prices
-
-
- Supply-Side Factors: Food prices are highly volatile due to weather conditions, agricultural productivity, and supply chain issues.
- Policy Challenges: Significant fluctuations make it difficult for monetary policy to manage inflation effectively, potentially leading to inappropriate responses.
-
- Focus on Core Inflation
-
-
- Stability and Reliability: Core inflation, excluding food and fuel, offers a more stable measure of underlying demand conditions.
- Effective Management: Targeting core inflation allows better management of aggregate demand without being swayed by temporary food price shocks.
-
- Ineffectiveness of Monetary Policy on Supply-Side Issues
-
-
- Demand vs. Supply: Monetary policy is designed to address demand-side factors, while food inflation is often driven by supply-side constraints.
- Limited Control: The RBI’s ability to influence food prices through interest rate adjustments is limited, suggesting that including food inflation may not be effective.
-
- Impact on Interest Rates
-
-
- Higher Rates: Including volatile food prices in inflation targeting can lead to higher interest rates for extended periods.
- Economic Growth: Persistent high rates due to food inflation can stifle economic growth and investment. Focusing on core inflation allows for more timely and effective monetary policy adjustments.
-