Why RBI cannot ignore food price pressures in overall inflation management

An interesting and lively debate is currently underway in the country on persistently high food inflation and its implications for monetary policy. Although the issue is not entirely new and has been a subject of debate at least since the adoption of the flexible inflation-targeting regime, it was, in a way, reignited by comments in the latest Economic Survey. The Economic Survey noted that India’s inflation-targeting framework should consider targeting inflation without food prices. The underlying reasoning of economists at the Ministry of Finance is that higher food prices are often driven by supply-side issues, not demand-induced. Short-run monetary-policy tools are meant to contain price pressure originating from excess aggregate demand.

Reserve Bank of India (RBI) Governor Shaktikanta Das’ last monetary policy statement and subsequent public interactions have clarified the central bank’s position. First, the target given to the RBI is a 4 per cent consumer price index-based inflation rate and food items constitute about 46 per cent of the basket, which cannot be ignored. Second, high food-inflation rates affect household inflation expectations, which has implications for the trajectory of inflation outcomes. The minutes of the latest Monetary Policy Committee meeting—released on Thursday— showed Mr Das highlighting how persistent food inflation was making headline inflation rate sticky, and emphasised the need to keep expectations anchored. An analytical chapter in the latest monthly bulletin of the RBI has also addressed the issue. The research article by Deputy Governor Michael Debabrata Patra and others — though it does not represent the official view of the central bank — shows why the central bank cannot ignore food in overall inflation management.

The average food inflation rate at 6.3 per cent between June 2020 and June 2024 was significantly higher than the 2.9 per cent witnessed over the previous four years. The increase can largely be explained by multiple overlapping shocks, largely because of climate events and the distribution of monsoon. As a result, in 57 per cent of the months under consideration, the food inflation rate was at or above 6 per cent. Vegetable-price increases are usually considered transitory. However, a double-digit increase was witnessed in about 45 per cent of the months. Cereals and products witnessed an over 6 per cent inflation rate in 53 per cent of the months. Clearly, food inflation has been a serious challenge over the past few years. It is also worth highlighting that consistent high food inflation was witnessed despite the proactive intervention of the Union government in terms of putting export restrictions on food items, among others.

The article further shows “food inflation has a statistically significant positive impact on inflation expectations, while monetary policy has a significant negative impact”. High food inflation can lead to the unanchoring of inflation expectations, which could significantly complicate overall inflation management. It has also been found that food inflation influences input costs and output prices in both manufacturing and services sectors. It further notes that food prices have been putting upward pressure on the core inflation rate over the past few years, which has been offset by monetary policy. Therefore, the RBI cannot ignore pressure from food prices in overall inflation outcomes. The RBI expects the headline inflation rate to average 4.5 per cent this financial year. It is projected to be at 4.4 per cent in the first quarter of next financial year. Although some economists believe that the food inflation rate will come down significantly in the coming months, given its persistence in recent years, it makes sense for the RBI to remain cautious.