The essence of India’s inflation problem
Source: The Hindu
For Prelims:
- Economic Concepts:
- Headline inflation vs Core inflation
- Consumer Price Index (CPI)
- Food price inflation
- Inflation targeting
- Institutions:
- Reserve Bank of India (RBI)
- Economic Survey
- Economic Indicators:
- Food accounts for nearly 50% of household expenditure in India
- Food price inflation has been elevated since 2019
For Mains (GS III - Indian Economy):
- India's Inflation Problem:
- High food price inflation is driving overall inflation in India
- Food inflation has been consistently positive for the past 13 years
- Inflation Targeting Policy:
- Since 2016, RBI has been mandated to control inflation through interest rate variations
- RBI has missed its 4% inflation target for the past five years
- Proposal to Change Inflation Measure:
- Economic Survey suggests removing food prices from inflation target
- Article argues against this proposal, citing its potential negative impacts
- Limitations of Monetary Policy:
- Interest rate hikes may not effectively control core inflation
- Food price inflation influences core inflation through wage effects
- Policy Recommendations:
- Focus on supply-side measures to raise agricultural yields
- Need for a comprehensive approach to agricultural production
Highlights of the Article:
- The article critiques the suggestion to remove food prices from the inflation target.
- It emphasizes the importance of food prices in India's overall inflation and economic well-being.
- The piece argues that monetary policy alone cannot control inflation in India.
- It suggests that addressing food inflation requires focus on agricultural production and supply-side measures.
- The article highlights the interconnectedness of food prices, wages, and overall inflation in the Indian economy
UPSC EXAM NOTES ANALYSIS
1. Food Price and inflation
- Food price inflation has been significantly high by historical standards, with a nearly 10% year-on-year increase in June. This elevated food inflation trend has persisted since 2019, predating both the COVID-19 pandemic and the Ukraine conflict, suggesting that domestic factors are at play. Given that food makes up a substantial portion of the Consumer Price Index (CPI), overall inflation has also been unusually high.
- Since 2016, inflation control in India has been assigned to the Reserve Bank of India (RBI) through a process known as ‘inflation targeting,’ where the central bank adjusts interest rates to manage inflation.
- However, this approach has not consistently achieved the targeted 4% inflation rate over the past five years. Similarly, the Bank of England has had a mixed record, and the Federal Reserve in the United States, aiming for 2% inflation, saw it spike above 8% in 2022 before falling back close to the target. In all these instances, global food price fluctuations have played a significant role in inflation trends.
- This raises two questions regarding the suggestion from the Economic Survey to exclude food prices from the inflation target.
- The proportion of food expenditure is often seen as an indicator of living standards and poverty. A high share of food expenditure makes households more vulnerable to food price increases.
- Ignoring food prices in inflation targets overlooks a critical issue affecting a large segment of the Indian population. The argument that food price fluctuations are ‘transitory’ and will be followed by declines does not hold true for the Indian context.
- Food price inflation has consistently been positive since 2011-12, indicating a persistent problem that cannot be dismissed as merely temporary
| First, is it justifiable to exclude food prices given the objectives of economic policy? Second, is the RBI likely to be more effective in controlling core inflation compared to its record on headline inflation? The answer to both questions seems to be ‘no’. In India, food constitutes nearly 50% of household expenditure, which is exceptionally high compared to international standards (e.g., less than 10% in the U.S.). |
2. Target Core Inflation
- This brings us to the second concern: whether the RBI would be more effective by focusing solely on core inflation. The answer is relatively straightforward. Over the past 13 years, core inflation has only met the 4% target in one year, and even then, only marginally.
- This outcome is not surprising given our analysis, which identified two key factors. First, raising the RBI's repo rate does not effectively reduce core inflation as intended. In fact, higher rates may lead to increased inflation.
- This can be explained economically: while higher interest rates are meant to reduce demand, firms might raise prices to protect their profit margins as their working capital costs increase and revenues decline due to reduced aggregate output.
- Additionally, we discovered that food price inflation impacts core inflation. Food prices influence wages, which contribute to a firm’s overall costs, so rising food prices lead to higher wages.
- The impact of food prices on core inflation diminishes the practical utility of focusing solely on core inflation. It also provides a deeper insight: since labor is involved in all production processes, changes in food prices affect inflation across the entire economy. Monetary policy, which relies on adjusting interest rates, cannot effectively control inflation because the central bank cannot influence food prices.
- Since 1991, Indian political parties have been keen to align with Western practices, regardless of their relevance or potential harm to the country. Excluding food price inflation from the inflation target is one such practice
3. Significance of agricultural Production
- The increasing cost of food is central to India's inflation issue. Removing food prices from the official inflation measure will not address the ongoing inflation problem. If food prices continue to rise, as they have over the past five years, the RBI will struggle to manage core inflation.
- The current inflation in India can only be effectively addressed through supply-side measures that enhance agricultural output. While the challenges are significant, they are not beyond the capabilities of a country that overcame chronic food shortages more than fifty years ago.
- Success will require a thorough approach to agricultural production, focusing on controlling costs to ensure a stable supply at reasonable prices as the population and economy expand.
- Excluding food inflation from the inflation target without a strategy to control it would leave India vulnerable to ongoing threats to its citizens' living standards.
- The Economic Survey suggests compensating for the negative impact of rising food prices through income transfers to households.
- However, if food prices continue to outpace overall inflation, these transfers could consume an increasing portion of the Budget, reducing funds available for public goods. This situation is undesirable.
- The only viable solution is to manage the rise in prices across all goods, which is the current policy focus
4. Conclusion
Food price inflation plays a pivotal role in shaping overall inflation trends, particularly in economies like India where food constitutes a significant portion of household expenditures. The persistent rise in food prices not only impacts the cost of living but also challenges the effectiveness of monetary policies aimed at controlling core inflation
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Mains Practice Questions
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