Relevance: GS III
Context: The Economic Survey preceding this year’s Union Budget suggests excluding food prices from the Reserve Bank of India’s (RBI) inflation target, shifting focus to ‘core’ inflation instead of ‘headline’ inflation. This proposal has significant implications for inflation control, particularly given the persistent high food inflation in India. Analyzing this proposal requires understanding the recent inflation trends and the efficacy of current inflation control policies.
The Economic Survey’s suggestion to exclude food prices from the RBI’s inflation target reflects a critical policy shift with far-reaching consequences. Food inflation in India has been persistently high since 2019, contributing significantly to overall inflation. Given that nearly 50% of household expenditure in India is on food, removing food prices from inflation targeting could ignore the economic realities faced by a large portion of the population.
Historically, the RBI has struggled to meet its inflation target, often missing the 4% goal, despite its mandate since 2016 to control inflation primarily through interest rate adjustments. This approach, known as ‘inflation targeting,’ assumes a central bank can precisely manage inflation levels—a notion that recent global experiences have challenged.
Key Concerns:
Impact on Economic Policy Goals:
Excluding food prices from inflation targeting undermines the relevance of the inflation measure for a population heavily reliant on food. In India, where food constitutes a significant part of household expenses, this exclusion would detach inflation control from the realities of the average consumer.
The argument that food price fluctuations are transitory does not hold in the Indian context, where food inflation has not been negative for over a decade.
Efficacy of Core Inflation Targeting:
Evidence suggests that the RBI’s interest rate policies do not effectively control core inflation. In some cases, higher interest rates might even contribute to rising inflation by increasing firms’ costs, which are then passed on to consumers.
Furthermore, food prices influence core inflation, as they directly impact wages and production costs across sectors. Ignoring food prices thus renders core inflation targeting less effective.
Way Forward
- Strengthen Agricultural Supply Chains: Implement supply-side measures to boost agricultural productivity and stabilize food prices. This includes investment in modern farming techniques, irrigation, and storage infrastructure.
- Integrated Agricultural Policy: Develop a comprehensive agricultural policy focused on cost control and steady supply growth, ensuring food price stability as the population and economy expand.
- Balanced Inflation Targeting: Retain food prices within the inflation target while complementing monetary policy with fiscal measures to manage inflation, ensuring a more holistic approach to economic stability.
Excluding food prices from the inflation target would weaken India’s inflation control strategy and exacerbate the challenges faced by households, especially the economically vulnerable. A balanced approach that considers the unique structure of the Indian economy and integrates supply-side measures in agriculture is essential for maintaining price stability and protecting the standard of living.