Should the Reserve Bank of India (RBI) ignore food price increases while trying to bring inflation under control as the Economic Survey of this year has suggested? And can the Reserve Bank bring inflation under control with interest rate variations – practice ‘inflation targeting’ – a task given to it by a 2016 act of Parliament?
In an article in The Hindu of 17 August, 2024, titled, ‘The essence of India’s inflation problem,’ Pulapre Balakrishnan and M Parameswaran answer the questions in the negative. Both are professors at the Centre for Development Studies, Thiruvananthapuram.
‘Targeting,’ they say, conveys capacity and precision which the RBI has failed to demonstrate; it has not achieved the 4 percent inflation target in each of the past five years. If food price inflation were to be removed from ‘headline’ inflation would the RBI be able to control ‘core’ inflation? The authors say that in the past 13 years, annual core inflation has been within the 4 percent target only in one year, and that too barely.
The authors are not surprised because the RBI’s use of higher interest rates to check bank lending does not dampen core inflation, in their view, as claimed. It may compel firms to raise product prices to protect their profits. Higher bank lending rates raise the working capital cost of firms, and lowers their revenue as demand falls. And food price inflation is also a determinant of core inflation because it determines wages, which are part of a firm’s costs. Wages rise as there is food price inflation. Monetary policy working via changes in the interest rate cannot control inflation as the central bank has no control over the prices of food.
The second question is whether there is justification for removing the price of food from the inflation target? The authors say no to that too. This is because in India the share of food in household expenditure is close to 50 percent. This is very high by international standards. In the US, it is less than 10 percent.
The authors assert that the share of food in household consumption expenditure is a measure of the standard of living. A high share denotes poverty and makes the household vulnerable to food price increases. Taking it out of the inflation target means ignoring what matters most to a large section of the people. Food price increases cannot be dismissed as ‘transitory’ because that’s not the case in this country. Food price inflation has not been negative in any of the 13 years since 2011-12, the base year for the current consumer price index. It may be said that India in fact, has a ‘food inflation problem,’ because the spikes are not transient.
The solution to food price inflation is enhanced agricultural production and productivity so that food is available to a growing population at affordable rates. Food price inflation cannot be tackled with income transfers to households if it is higher than overall inflation as the transfers would absorb a rising share of the budget leaving less and less for other essential public expenditure.
Postscript: News agency PTI reported on 2 October, 2024 that former RBI Governor Raghuram Rajan was against excluding food from inflation targetting as it would erode people’s faith in the central bank: Former ReserveBank of India (RBI) Governor
Raghuram Rajan has said that he is against excluding food prices from headline inflation, as it would erode the ‘great faith’ of
people in the central bank, which has been mandated by the government to keep inflation in check.
“When I came into office, we were still targeting PPI (producer price index). Now that has no bearing to what the average consumer faces. “So, when the RBI says inflation is low, look at PPI, but if the consumer is facing something very different, then they do not really believe that inflation is down,” he said responding to a question on suggestions made in the Economic Survey 2023-24 for excluding food inflation while setting benchmark interest rates.
Rajan, who is currently a professor of finance at US-based Chicago Booth, said the argument against excluding food inflation is that ‘you cannot affect it’.
(Top photo by Vivian Fernandes)