Economic Survey signal: Keep food prices out of retail inflation while deciding interest rates

• Noting that the anticipated monetary policy easing by the Reserve Bank of India (RBI) has been delayed, the Economic Survey for 2023-24 has made a case for changing the inflation targeting framework of the central bank by excluding food prices.

Highlights:

• “Despite the core inflation rate being around 3 per cent, the RBI, with one eye on the withdrawal of accommodation, and another on the US Fed, has kept interest rates unchanged for quite some time, and the anticipated easing has been delayed.
• Headline retail inflation has remained over 5 per cent for eight months in the last one year. It has largely been high food prices, especially of vegetables, pulses and cereals, which has kept the headline retail inflation sticky; food items contribute 46 per cent to the consumer price index basket. However, retail core inflation - the non-food and non-fuel segment - moderated to a four-year low of 4.3 per cent in FY24.
• In fact, this is one reason why RBI hasn’t been able to cut interest rates. Even though actions on policy rate do not influence food prices, the worry that high food inflation may become generalised is holding back the central bank.
• On India’s inflation targeting framework, the Survey said inflation targeting should be considered, excluding food, as higher food prices are, more often, not demand-induced but supply-induced.
• Short-run monetary policy tools are meant to counteract price pressures arising out of excess aggregate demand growth, it said, adding that it is “worth exploring whether India’s inflation targeting framework should target the inflation rate excluding food”.
• “Hardships caused by higher food prices for poor and low-income consumers can be handled through direct benefit transfers or coupons for specific purchases valid for appropriate durations.
• In May 2016, the RBI Act, 1934, was amended to implement the statutory framework for flexible inflation targeting, under which average inflation more (or less) than the upper (or lower) tolerance band of the inflation target for any three consecutive quarters is considered as a failure in meeting the inflation target.
• At present, the RBI’s target for headline retail inflation is 4 percent with a band of plus or minus 2 percent.
• The agreement between the RBI and the government in 2016 had also acknowledged that the range under the inflation targeting regime will accommodate data limitations, projection errors, short-run supply gaps and instability in the agriculture production — an important factor for CPI inflation, as food articles have a major weight in the CPI indices.
• Many countries have established their own inflation targets based on various factors that serve their economic objectives best, the Survey said. Factors such as the level of economic development, the structure of the economy, the state of the financial system, and the trade-off between inflation and other economic objectives may influence these targets.

Prelims Takeaway:

• CPI
• RBI Act 1934