India’s food basket impact on inflation
We are not talking about the amount of roti and rice on the table that is causing the problem, but India is deep into the trouble of having a high share of food in the consumption basket and the very fact that food price pressures are a big headwind in an economy that has high income inequality.India is set to remain the fastest-growing major economy in 2024, according to the IMF. But remember, it is still a country that has to provide free food grain to 800 million.
RBI MPC maintains steady stance on inflation
The Reserve Bank of India’s Monetary Policy Committee, who left rates and stance unchanged for the ninth time, has decided to focus on inflation and support price stability to ensure growth. While economists flagged that food inflation remains a hurdle, the RBI too sounded caution on it.
Food inflation surge and RBI’s challenge to ease price pains
In June, food inflation surged significantly, raising the overall Consumer Price Index (CPI) inflation to 5.1 percent, up from 4.8 percent in May. The spike in food prices, particularly for vegetables, cereals, milk, and fruits, has been a major contributor to this increase. Despite a favorable base effect from last year, food inflation soared to 9.4 percent, driven mainly by consistently high vegetable prices, which have stayed in double digits for eight months.
India’s central bank, who along with the government has to ease price pressure in the world’s most populated country, today acknowledged that food inflation pressures cannot be ignored. While inflation in other sectors is under control, food inflation in India has remained persistently high.
This is due to the unpredictable nature of weather affecting food production and inefficiencies in the agricultural sector.
Also Read: RBI MPC Meet Highlights 2024: Das & Co keeps rates and stance unchanged
The government has been actively working to keep food prices low by selling vegetables and pulses at reduced rates, imposing stock limits, and implementing export restrictions. It also has to carefully balance protecting farmers’ interests by avoiding excessively low prices while also ensuring prices don’t rise too high for consumers, particularly the poor.
Food in inflation basket
India’s Chief Economic Adviser, V Anantha Nageswaran, suggested in the Economic Survey that the central bank’s inflation target should exclude food. However, several economists disagreed, stating this approach is not suitable for India. A government panel is considering a significant reduction in the weighting of food in the consumer price index (CPI) to help control inflation spikes. According to Bloomberg, the panel under the statistics ministry is discussing a proposal to reduce the weight of food in the CPI basket by up to 8 percentage points. Currently, the food and beverage category accounts for 54.2% of the CPI basket.
CPI is currently based on consumer spending patterns from 2011-2012, which economists argue are outdated and might be skewing the official inflation data that the central bank relies on to set interest rates.
“First and foremost is the fact that our target is the headline inflation wherein food inflation has a weight of about 46 per cent. With this high share of food in the consumption basket, food inflation pressures cannot be ignored,” RBI Governor Shaktikanta Das said.
Moreover, the general public perceives inflation mainly through the lens of food prices rather than other components of overall inflation. Therefore, India cannot and should not become complacent just because core inflation has decreased significantly, Das said.
India’s inflation index is heavily influenced by food prices because most people spend a significant portion of their income on food.
“India’s share of food and beverage in the CPI basket currently stands at 46% which is much higher than developed countries or even emerging countries like Brazil, China and South Africa where the weight ranges between 20-25%. Even though the share of food in the inflation basket is expected to fall in the new series to ~43% after the 2024 household consumption survey, it will still continue to remain high,” Rajani Sinha, Chief Economist at CareEdge, told ET Online.
Developed countries find inflation targeting easier due to the low share of food in their inflation baskets, but it’s more challenging for economies like India, she added.
Monetary policy mainly affects demand but struggles with supply-driven food inflation, especially when food demand is price inelastic. While the Economic Survey suggests excluding food from CPI inflation for monetary policy, food inflation cannot be entirely disregarded, Sinha said, adding the central bank must balance its approach, considering both core and food inflation trends and their impact on overall CPI. Seasonal food price fluctuations, like those for vegetables, can be ignored if they seem temporary.
RBI MPC flags food price shocks
Ongoing food price shocks have slowed the process of disinflation in the first quarter of this fiscal year. There is also a significant gap between headline and core inflation. This raises the question of how much emphasis the MPC should place on food inflation, the governor said.
Marking a significant departure from earlier meetings, the RBI Governor spent a fair amount of time in flagging the issue of high food inflation. This is important since food inflation remains a burning point for consumers and policy makers alike, Aditi Gupta, economist at Bank of Baroda, told ET Online.
“With food inflation remaining elevated for the past few months and a high share of food items in the inflation basket, the transitory supply side shocks in food prices can have a detrimental impact on consumers’ inflation expectations. This is compounded by the fact that a few items of the food basket are exhibiting maximum volatility, with the seasonal impact on prices proving to be much more intrinsic in nature,” she said.
Shaktikanta Das today also said high food inflation negatively impacts household inflation expectations, which significantly influence the future path of inflation.
Also Read: What RBI Governor Shaktikanta Das didn’t say about MPC status quo: It is the growth
After a moderating trend between May 2022 and September 2023, household inflation expectations have risen again due to high food inflation since November 2023, he said.
“The MPC may overlook high food inflation if it is temporary; however, in the current environment of persistent high food inflation, the MPC cannot afford to do so,” Shaktikanta Das said.
RBI said it must stay vigilant to prevent spillovers or secondary effects from persistent food inflation and maintain the credibility of its monetary policy.
Persistently high food inflation and unanchored inflation expectations could lead to spillovers into core inflation through increased wages driven by cost-of-living concerns. Firms might then pass on these higher costs by raising prices for goods and services, particularly in a strong demand environment. This chain of events can make overall inflation remain stubbornly high, even after food inflation subsides, the RBI flagged.
“Food inflation is a hurdle and without a durable decline in it, headline inflation cannot be tamed to 4% on a sustained basis,” said Dharmakirti Joshi, chief economist at CRISIL.
RBI MPC’s inflation forecast and future projections
While announcing the monetary policy decision, Das said the RBI has decided to leave the inflation forecast for this fiscal year at 4.5%. However, it raised the inflation projections for the second and third quarters to 4.4% and 4.7% from 3.8% and 4.6% forecast in June policy.
Das also flagged that anticipated easing of headline inflation in the second quarter of this fiscal year (from 4.9% in first quarter), due to a favorable base effect, may reverse in the coming quarters. While India has a significant advantage in the third quarter that could help lower inflation, this base effect will diminish in the future, he added.
Also Read: RBI leaves inflation projection for FY25 unchanged at 4.5%
The central bank has left rates and stance unchanged, while it closely monitors inflation trends and associated risks. The RBI seeks to remain committed to disinflation and steadfast in achieving a sustained inflation target of 4%.
The country’s retail inflation was closest to the 4%-mark last in January 2021 at 4.06%.
“Today’s cautious communication from the RBI confirms that it is likely to focus on headline inflation even if core inflation pressures have moderated,” said Sakhsi Gupta, principal economist at HDFC Bank.