Chief Economic Adviser V. Anantha Nageswaran added to the debate by noting that removing volatile items such as tomatoes, onions, potatoes, and precious metals from the Consumer Price Index (CPI) calculation would lower the headline inflation rate to 4.2% in October.
The Role of Food Prices in Inflation
The prices of essential food items like tomatoes, onions, and potatoes (collectively referred to as TOP) have been key contributors to the recent spike in retail inflation, pushing it above the Reserve Bank of India’s (RBI) upper tolerance limit of 6%. Seasonal supply disruptions have been blamed for the surge, with expectations that prices will normalize once supplies stabilize.
Economists argue that food inflation cannot be overlooked, as it carries significant weight in the CPI basket. Persistent high food inflation influences broader inflationary expectations. Over the past two years, elevated food inflation has complicated monetary policy decisions, presenting policymakers with a challenging balancing act.
India’s Monetary Policy Framework
India’s inflation targeting framework, introduced through amendments to the RBI Act in 2016, established a statutory basis for inflation control. The framework sets a target inflation rate of 4%, with a tolerance band of 2% to 6%. This target, based on the CPI, was extended for another five years in March 2021, continuing until March 31, 2026.
Calls for Rethinking the Framework
The latest Economic Survey sparked the debate by suggesting the exclusion of food prices from the inflation targeting framework. It argued that food price inflation is often driven by supply-side issues rather than demand, and using short-term monetary tools to address supply constraints could be counterproductive. The Survey, authored by Nageswaran, proposed alternative measures like direct benefit transfers or targeted coupons for low-income groups to alleviate the impact of higher food prices.
Why Food Inflation Cannot Be Ignored
RBI Governor Shaktikanta Das emphasized that food inflation accounts for around 46% of the headline inflation index. Addressing the monetary policy committee (MPC), he highlighted that food inflation heavily influences household inflation expectations, which are critical for the future trajectory of overall inflation.
Das warned against complacency, even as core inflation (excluding food and fuel) has shown a downward trend. He noted that persistent food inflation could lead to second-round effects, such as higher wages, which would then spill over into core inflation.
While the MPC may choose to look past short-term spikes in food inflation, Das stressed that prolonged high food inflation requires vigilance to preserve the credibility of monetary policy. He added that the authorities cannot ignore the reality that the public perceives inflation largely through the lens of food prices. High food inflation affects households directly and must be addressed to anchor inflation expectations and ensure overall economic stability.
As the debate continues, policymakers face the dual challenge of managing supply-side disruptions and preventing inflationary expectations from becoming entrenched, while ensuring the framework remains robust and relevant to India’s unique economic conditions.
(with ToI inputs)