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A recent agreement between the government and the Reserve Bank of India will regard the apex bank as having failed if it cannot control inflation. But food inflation, which contributes about 46 per cent to overall inflation, is determined by supply and cannot be directly controlled by monetary policy. Experts said since flexible inflation targeting was now the objective, the RBI could not escape its responsibility even if food prices were affected by an imperfect supply situation. CPI inflation rises to the double digits by a mere 2.5 percentage point increase in the price of food. Monetary policy can at best prevent food inflation from spreading across the economy through wage hike demands.
"It is the responsibility of the central bank to ensure price stability. It cannot give up this responsibility even if food prices are rising," C Rangarajan, former RBI governor, told Business Standard.
The framework agreement between the finance ministry and the central bank says the primary target of monetary policy will be price stability, keeping in mind the objective of growth. The RBI will be considered to have failed in controlling inflation if the rate of price rise, as shown by the CPI, moves out of the two to six per cent band for three consecutive quarters beginning 2015-16. Rangarajan said if food prices were rising, other prices could be tamed. If it became difficult for the RBI to control inflation, the central bank could provide the reasons in a public statement, he added.
The central bank's failure report to the government must propose remedial action and an estimate of the time within which the target will be achieved. The agreement also requires the RBI to publish every six months the sources of inflation and forecasts for the next 6-18 months.
"It (the central bank) could say fiscal expansionary policies of the government were coming in the way and should be rectified to keep inflation under control," Rangarajan, former head of the prime minister's economic advisory council, said. DK Joshi, chief economist of credit rating agency CRISIL, said the RBI's monetary tools were more effective in reining in core inflation, which excludes food and fuel, than food inflation. "It can always list the measures the government needs to take to bring down inflation," he said. Experts said the RBI could bring down inflation, but policymakers would have to prepare for a deliberate economic slowdown. The monetary policy committee, which is to decide on the monetary stance, is yet to be constituted because it needs an amendment in the RBI Act.
The base year for the CPI series was recently advanced to 2012 from 2010. Weights were also reassigned on the basis of a national consumption expenditure survey in 2011-12.
The new CPI series is not available prior to December 2014. Since then, CPI inflation has broadly been within target. In December CPI inflation was 4.28 per cent, in January 5.19 per cent and in February 5.37 per cent. Food inflation has been moderate as well, it was 6.79 per cent in February.
On the basis of the old series, however, CPI inflation was in the range of 8-11 per cent between April 2013 and May 2014. It rose from 10.17 per cent in October 2014 to 11.16 per cent in November 2014. Food inflation rose from 12.56 per cent to 14.72 per cent, with the price rise in vegetables accelerating from 45.67 per cent to 61.60 per cent, during that period.
