Excluding food from RBI's inflation framework may not have many takers

Headline numbers best communicated to common man; Govt needs to step up supply management

Excluding food inflation from the Reserve Bank of India’s (RBI’s) inflation-targeting framework, an idea the Economic Survey has floated, has not found favour with most economists and central-bank watchers.

Calling for a re-examination of the framework, the Survey said when food prices rose, inflation targets came under threat, prompting the central bank to appeal to the government to bring down prices of food products. This, in turn, prevents farmers from benefiting from the rise in prices.
 

One of the reasons for adopting the consumer price index as the RBI’s target is that it is easy to communicate to the people.

“It is the food prices that matter the most. Governments have fallen due to high onion prices,” said a central-bank watcher.

A committee headed by former RBI governor Urjit Patel (he was deputy governor then) had recommended the CPI to be the RBI’s target.
 

In May 2016, the RBI Act, 1934, was amended to provide a statutory basis for implementing the flexible inflation-targeting framework. On March 31, 2021, the central government retained the inflation target and the tolerance band for the next five-year period — April 1, 2021, to March 31, 2026. The RBI’s retail inflation target is 4 per cent, with a variation of 2 per cent on either side.

 

“The core-CPI basket (ex-food and energy) is linked to items whose prices are driven by supply-side dynamics or global factors, such as gold. Removing all of these to come to the basket of items whose prices purely reflect domestic demand conditions will shrink the index relative to items that are purchased by consumers,” said Aditi Nayar, chief economist, ICRA. “The transmission of a sustained rise in food prices into rentals and other components of the core inflation can’t be ruled out,” Nayar added.
 

The food inflation rate has remained high for some time and the central bank has said elevated food prices have made the “last mile of disinflation” slow.
 

A recent RBI report said the argument that food price shocks were transitory did not seem to be borne out by the experience over the past one year, and said it was too long a period for a shock to be termed transitory.
 

Economists have also countered the argument that food price shocks are supply-side issues, on which the monetary policy tools have a limited impact.
 

“While immediate price effects are due to supply shocks, demand has been building over time, which contributes to price rise. As people move to higher-value goods like coarse cereals, there is a demand-side issue,” said Madan Sabnavis, chief economist, Bank of Baroda.
 

No central bank targets core inflation and “hence doing so will be odd”, said Sabnavis.
 

Most central banks except the United States Fed target headline inflation. The Federal Open Market Committee (FOMC) judges that an inflation rate of 2 per cent over the longer run, as measured by the annual change in the price index for personal consumption expenditures, is most consistent with the Fed’s mandate for maximum employment and price stability.
 

“By targeting inflation without food, the central bank may well be targeting an inflation index that does not impact inflation expectations -- an important indicator that monetary policy is actually trying to target when reacting to more supply induced price pressures. Inflation expectations, or perceived inflation by households, has the potential to fuel headline inflation, reducing the effectiveness of a non-food inflation targeting monetary policy system,” wrote economists at Barclays while suggesting a lower weighting of food in the CPI index, which would mean that while targeting headline inflation, the RBI is not effectively targeting only food prices.
 

The rise in prices of food items like cereals and pulses -- in double digits or close to double digits for more than a year -- has brought supply side management issues to the fore.
 

“Supply-chain management is critical but hard, given the paucity in storage of various crops. Also disposing of the stuff becomes difficult when stocks are plentiful,” Sabnavis said.