The Reserve Bank of India’s (RBI’s) inflation targeting regime has worked well and need not be abandoned in favour of a more discretionary regime that could be risky and counterproductive, a new research paper has said.

The paper titled ‘Inflation Targeting In India: A Further Assessment’ said the weight of food-price inflation in the CPI inflation basket should be reduced to better reflect the circumstances of Indian households.

“The RBI’s inflation targeting regime has worked well. Given this record, radical changes such as broadening its mandate or abandoning the target in favour of a more discretionary regime would be risky and counterproductive,” it said.

The paper is authored by economists Barry Eichengreen (University of California, Berkeley) and Poonam Gupta (NCAER).

In contrast, the paper noted that the 4% point target, +/-2 percentage point tolerance band and focus on headline inflation remain broadly appropriate.

“That said, the regime can be tweaked to improve performance,” it suggested.

The government and the RBI signed an inflation-targeting agreement in February 2015 and amended the RBI Act in May 2016.

The inflation target was set by the government in consultation with the RBI with the possibility of revisiting it after five years.

Accordingly, the government announced, via the Official Gazette, 4% Consumer Price Index (CPI) inflation as the target from August 5, 2016, with an upper tolerance limit of 6% and a lower limit of 2%.

For the most part, the paper pointed out that targets set under the inflation-targeting agreement have been met; and on almost all counts, it has performed as envisaged.

“It has been only once that inflation exceeded the upper tolerance band of 6% for three consecutive quarters (during January 2022-September 2022),” the paper said.

According to the paper, evidence points to improved outcomes during inflation targeting.

“Inflation is lower and less volatile; inflation expectations are better anchored, and the transmission of monetary policy is more effective,” it said.

Recently, Chief Economic Advisor V. Anantha Nageswaran had pitched for excluding food inflation from the rate-setting calls, saying that the monetary policy has no bearing on the prices of food items, which are dictated by supply-side pressures.

Finally, contrary to earlier scepticism, the paper argued that it does not appear that the inflation-targeting agreement has made the RBI overly hawkish or reactive to every small deviation in the inflation rate from its target of 4% or to every spike in food inflation.

Since September 2016, the RBI has changed the key policy rate 17 times, the majority of them during two turbulent years — in 2019-20 when the policy rate was eased five times by a cumulative 185 basis points in response to a sharp growth slowdown; and in 2022-23 when the policy rate was increased six times by a cumulative 210 basis points in response to accelerated inflation emanating from global shocks.

During the remaining six years, the policy rate was changed only six times, about once every year. Compared to this, the RBI changed its policy rate 24 times in the eight years prior to IT.

India’s wholesale prices rose 3.36% in June from a year earlier, government data showed on July 15, 2024. File
| Photo Credit: ANI

Inflation in India’s wholesale prices accelerated to 3.4% in June, the highest in 16 months, from 2.6% in May, led by a spike in food inflation to 8.7% and a near-doubling in the rise of manufactured products prices to 1.43%.

Pricier vegetables, cereals, and fruits spurred the rise in food prices paid by Indian consumers to a six-month high of 9.4% in June, escalating the headline retail inflation pace to a four-month high of 5.08% in June, from a revised 4.8% in May, as per data released on Friday.

On a month-on-month basis, wholesale prices were up 0.4% in June, with the Food Index rising 2.5%, the fastest so far this calendar year, and over four times the 0.6% pace recorded in May.

By contrast, manufactured products costs rose 0.14% over May in June, the slowest rise in four months, while fuel and power inflation remained sequentially negative for the fourth straight month at -1.93%

The problem of high food inflation will be “less severe” in India going ahead, as modern supply chains with diversified sources can help quickly address sudden spikes in prices of specific food items, RBI Monetary Policy Committee (MPC) member Ashima Goyal said on April 25.

Stressing that the share of food in the household budget is high in India, Ms. Goyal said policy needs to focus on increasing agricultural productivity, since stable agricultural prices are important for non-inflationary growth.

Also Read | Extreme weather may pose risk to inflation, says RBI Bulletin

“As India develops, this problem (high food inflation) will get less severe, for a number of reasons. Modern supply chains with diversified sources respond quickly to large spikes in specific items,” she told PTI.

Ms, Goyal further pointed out that one does not hear of tomato or onion prices spiking in advanced economies.

“We naturally have diverse geographic regions, better integrated markets sourcing from different regions can help mitigate climate change induced food price spikes,” she said.

Moreover, as the weight of food in consumption falls and food consumption itself becomes more diversified, the impact and size of future food price shocks falls, she noted.

Ms. Goyal stressed that under flexible inflation targeting, expectations get better anchored.

She cited the example of East Asia, where food prices were allowed to rise and agriculture was subsidized only after food budget shares fell.

Also Read | Inflation drops to 10-month low in March, but no relief on food bills yet

“India unfortunately opted for a distorting system of subsidies to farmers as well as to consumers,” she said, adding that given India’s huge population this was very expensive and reduced the space for government investment in agriculture.

Besides, Ms. Goyal said it also kept inflation high as procurement prices rose each year.

She said agricultural productivity is finally rising supported by a policy reset, along with the availability of new technologies even though further policy adjustment is required, she stressed.

According to official figures, retail inflation declined to a five-month low of 4.85% in March, mainly due to cooling down of food prices. The inflation in the food basket was at 8.52% in March, down from 8.66% in February.

RBI Governor Shaktikanta Das has recently said that the baseline projections show inflation moderating to 4.5% in 2024-25, from 5.4% in 2023-24, and 6.7% in 2022-23.

Replying to a question on India’s current macroeconomic situation, Ms. Goyal said conditions have been created for sustainable and inclusive growth.

“We are seeing results since 2021 with continued robust growth, reduction in multi-dimensional poverty, more assets and infrastructure sustainably helping the lower income groups, more opportunities for youth,” she said.

Ms. Goyal said inequality has risen but the famous ‘Kuznets inverted U-curve’ tells us that this is normal in a period of high growth and should come down over time.

But for the economy to continue on such a path, the eminent economist said policy continuity is very important.

“Policy lessons on what worked must be internalized, domestic policy shocks avoided and external shocks smoothed, even as supply-side enabling reforms continue,” Ms. Goyal suggested.

She emphasised on the need of enhancing the economy’s resilience and diversity saying, “we live in troubled times of geopolitical, geoeconomic and climate fragilities.”

Also Read | Indian economy projected to grow 6.5% in 2024: UNCTAD

During 2023-24, the economy is likely to record a growth rate of near 8% on account of good performance of manufacturing and infrastructure sectors.

Recently, the International Monetary Fund (IMF) raised India’s growth projection to 6.8% for 2024, from its January forecast of 6.5%, citing bullish domestic demand conditions and a rising working-age population.

The Asian Development Bank (ADB) also raised India’s GDP growth forecast for the current fiscal to 7%, from 6.7% earlier, saying the robust growth will be driven by public and private sector investment demand and gradual improvement in consumer demand.

A similar easing was recorded in pulses, whose prices rose 17.7% in March, 2024, from 18.5% in February.
| Photo Credit: Sushil Kumar Verma

India’s retail inflation moderated to a ten-month low of 4.85% in March from 5.1% in February, but food inflation remained sticky at 8.52%, little changed from the 8.66% recorded in the previous month as price rise accelerated in cereals and meat, while vegetables, pulses, spices and eggs remained in double-digit inflation.

While inflation for urban consumers cooled significantly from 4.8% in February to 4.14% in March, rural consumers had it harder as they experienced a slightly higher inflation of 5.45% in March compared with 5.34% in the previous month.

This trend was visible in the extent of food price rise as well, as it accelerated from 8.3% in February to 8.6% in March for rural India, while the food inflation for urban consumers dropped from 9.2% in February to 8.35% last month.

On a month-on-month basis, there was no change in the Consumer Price Index but the food price index inched up about 0.2% and economists reckoned that the ongoing heat wave could spike food inflation in coming months. Even as crude oil prices are firming up and an inflation spike in the US may delay hopes of interest rate cuts from the Federal Reserve, sticky food inflation at home could further dampen prospects of rate cuts from India’s central bank.

While March’s inflation rate is still aloof from the bank’s stated 4% target, average retail price rise in the last quarter of 2023-24 has been 5.01%, in line with the 5% average projected by the Reserve Bank of India (RBI).

The RBI, which last week called Inflation the elephant in the room that needs to return to the forest for good, expects retail inflation to ease to an average 4.5% this year from the 5.4% clocked in 2023-24. The ongoing April to June quarter is, however, expected to see an average inflation of 4.9%, as per the RBI.

Within the food basket, vegetables’ inflation cooled marginally from the seven-month high of 30.25% in February to 28.3% last month. A similar easing was recorded in pulses, whose prices rose 17.7% in March from 18.5% in February, eggs (up 10.33% from 10.7%), sugar (up 7.25% compared with 7.5% in February.

Also read | What causes inflation in India: Demand or supply issues? | Data 

However, the price rise in cereals spiked to 8.4% in March from 7.6% in the previous month, and rose to 6.4% for meat and fish, from 5.2% a month earlier. Spices inflation remained over double digits at 11.4%, moderating from 13.5% in February.

Food prices continue to be under pressure with cereals, vegetables, spices and pulses seeing high inflation and the present heat wave poses an upside risk,” said Bank of Baroda economist Madan Sabnavis, who added that recent price hikes by fast moving consumer goods firms is another monitorable.

Although inflation in household goods and services, as well as health and education, eased slightly from February levels, personal care and effects prices surged at a faster pace of over 6% in March from 5.2% the previous month.

“While core inflation continues to moderate, we remain wary of the heatwaves going ahead which could keep food inflation elevated and volatile in the summer months,” said Upasna Bhardwaj, chief economist at Kotak Mahindra Bank. Ms. Bhardwaj expects any possible interest rate cuts only in the latter half of this fiscal year, depending on monsoons’ performance, the trajectory of crude oil prices and the timing of the US Fed’s rate easing cycle.

Rating agency ICRA expects food and beverages inflation, which was 7.8% in March, to persist over 7% in April as well. “An intensification of the impending heatwave may worsen the seasonal uptick in prices of perishables, heightening the criticality of a favourable monsoon this year to keep food inflation in check and anchor inflationary expectations,” its chief economist Aditi Nayar stressed.

The Congress on Sunday alleged that the government has mismanaged the economy across all sectors and since it is “too inept” in fixing issues such as unemployment and price rise, it is distorting the data instead.

Congress general secretary Jairam Ramesh said now that the special session of Parliament is over, it is clear that the Modi government was trying to “distract and divert” the nation from some critical issues – “the Adani scam, the caste census and especially the rising unemployment, growing inequality and the economic distress”.

In a statement, he said no matter how much the Modi government hides the data, the reality is that the vast majority of people are suffering.

He claimed that some of the facts reported last week are being “brushed under the carpet”.

He said RBI’s latest bulletin of September 2023 shows the “complete failure” of the Modi government to execute a recovery from the COVID-19 pandemic.

“43% of people were in the labour force in February 2020. Over 3.5 years later, the participation rate remains around 40%. As a matter of grave concern, a report from Azim Premji University shows that over 42% of graduates under the age of 25 were unemployed in 2021-22,” Mr. Ramesh said.

In 2022, women were still making only 85% of their earnings before the pandemic, he claimed.

“Remember that India was already facing the highest unemployment rate in 45 years before the onset of the pandemic — a statistic that the Modi government tried hard to hide from the public domain,” he alleged.

The Congress leader highlighted that the prices of essential commodities have been rising sharply, impacting the household budget of ordinary families.

“After the uncontrolled spike in tomato prices, now tur dal prices are up 45% from January 2023, and overall pulses inflation has touched 13.4%. Prices of atta are up 20% since August, besan is up 21%, gur is up 11.5%, sugar is up 5%,” Mr. Ramesh said.

Uncontrolled price rises across the essential household sector shows the inability of the Modi government to manage the economy, he added.

Mr. Ramesh also alleged that the crony capitalism of the Modi government has concentrated all economic benefits to a select few firms, making it next to impossible for MSMEs to compete.

“A report by Marcellus found that 80% of all profits went to just 20 companies in 2022. In contrast, the market share of small business was at its lowest level in India’s history; small business sales were around 7% of the total before 2014 but fell to under 4% in Q1 2023. Seventy-five% of small businesses are losing money, according to a 2023 survey of 100,000 small business owners by Consortium of Indian Associations,” he said in his statement.

Noting that credit to the private sector is the engine of growth, Mr. Ramesh said a decade of stagnant credit is a symptom of a mismanaged economy.

According to World Bank data shown in last week’s RBI bulletin, from 2004 to 2014, domestic credit to the private sector grew consistently and rapidly, he said.

“Credit grew from 36.2% of GDP in 2004 to 51.9% of GDP in 2014. However, since 2014, credit growth has stagnated. In 2021, domestic credit was at just 50.4% — lower than it was in 2014!” Mr. Ramesh said.

It should be a matter of grave concern to the government that household financial liabilities have been growing rapidly, the Congress leader asserted.

The Finance Ministry wants us to believe that people are buying homes and vehicles, but RBI data shows that there is a major spike in gold loans by 23% and personal loans by 29%, over the past year – clear signs of distress, as people go into debt to meet basic expenses, Mr. Ramesh said.

“Further, RBI data shows household savings growth has come down sharply, from 7.2% of GDP in FY22 to just 5.1% in FY23. This is a 47-year low in savings growth rate, and reflective of the overall slowdown in the Indian economy under the Modi Government,” he said.

Mr. Ramesh said that for the first time in a decade, FDI inflows have declined in India.

The RBI bulletin showed that FDI decreased 16% in FY23, he pointed out.

Further, as a percentage of GDP, after more than doubling from 0.8% in 2004 to 1.7% in 2014, FDI has been stagnant — inflows were just 1.5% of GDP in 2022. Foreign investors are increasingly unwilling to put their money in India due to the Modi Government’s crony capitalism, failed economic policies, and stoking of communal tensions,” he alleged.

“From increasing unemployment, rising prices of household essentials, shrinking MSME sales, slow domestic credit growth, increased household financial liabilities and decreased savings, and declining FDI, the Modi government has mismanaged the economy across all sectors,” Mr. Ramesh said.

Ordinary families and small businesses are under intense pressure, but the government is “too inept to fix it and so is busy distorting the data instead”, he claimed.

The Congress has been attacking the government over its handling of the economy and raising concerns over “increasing unemployment and price rise”.

New Delhi:

Reserve Bank Governor Shaktikanta Das today said the central bank is committed to bringing down inflation to 4 per cent and will remain watchful of risks as more frequent global supply shocks can have profound implications on the management of the price situation.

Delivering a lecture at the Delhi School of Economics, the governor said the RBI remains on guard to ensure that the second-order effects in the form of generalisation and persistence with regard to inflation are not allowed to take hold.

The central bank has been mandated by the government to keep inflation at 4 per cent with a margin of 2 per cent on either side.

“The frequent incidences of recurring food price shocks pose a risk to the anchoring of inflation expectations, which has been underway since February 2022. We will remain watchful of this aspect also.

“The role of continued and timely supply side interventions as is being undertaken by the government assumes criticality in limiting the severity and duration of such food price shocks,” he said.

In these circumstances, he said, it is necessary to be watchful of any risk to price stability and act timely and appropriately.

“We remained firmly focused on aligning inflation to the target of 4 per cent,” he said without giving any time frame.

He also said that inflation, which had touched a high of 7.4 per cent in July, driven by a rise in vegetable prices, has started moderating.
 

Grocery item put on display for sale at a market, in New Delhi. File
| Photo Credit: Sushil Kumar Verma

India’s inflation woes are not over yet but food price spikes may be “transitory”, the Finance Ministry said on August 22, attributing the latest spike in headline inflation to global uncertainties triggered by the termination of the Black Sea Grain Initiative that has upset wheat and edible oil supplies, as well as disruptions in domestic farm output.

The impact of the global disruptions was “clearly evident” in the sharp surge in the retail inflation pace in July to a 15-month high of 7.44%, the Ministry said, noting that the 11.5% food inflation rate was “perhaps the third highest” since the current Consumer Price Index (CPI) series began in 2014. Core inflation, which excludes energy and food costs, was at a 39-month low of 4.9%, it emphasised.

The global uncertainty and domestic disruptions may keep inflationary pressures elevated for the coming months, warranting greater vigilance from the government and the central bank, the review stressed, underlining the need to bring the focus back on maintaining macroeconomic stability.

“Cereals, pulses and vegetables exhibited double-digit growth… [but] only 48% of food items have inflation of above 6%, and this includes 14 food items with inflation in double digits. Items like tomato, green chilli, ginger and garlic witnessed inflation of more than 50%,” the Ministry said in its monthly economic review for July.

Holding these “abnormal” upticks in some items responsible for fuelling high food inflation last month, the review said this is expected to be transitory. “Tomato prices are likely to decline with the arrival of fresh stocks by the end of August or early September. Further enhanced imports of tur dal are expected to moderate pulses inflation,” it pointed out, arguing that these and other government efforts “can soon materialise moderation in food inflation in the coming months”.

Dry conditions

Apart from the termination of the Black Sea Grain Initiative which has created “disorderly conditions around the supply of wheat and sunflower oil”, the Ministry noted that continued dry conditions in Canada and the U.S. have caused wheat prices to rise. “Subdued production growth of oil palm in Malaysia and concern over the production outlook of soybeans and rape seed in the U.S. and Canada led to a spike in vegetable oils price,” it added.

“Disruption in domestic production also aggravated the inflationary pressures. Interruption in the supply chain of tomatoes due to white fly disease in Kolar district, Karnataka and the swift arrival of monsoon in northern India caused a surge in tomato prices. Tur dal price also inflated due to deficient production in the Kharif season [of] 2022-23.”

Domestic consumption and investment demand are expected to continue driving India’s growth, but further global monetary tightening could hurt stock markets in emerging economies, the Ministry cautioned.

The decline in the inflation rate in June is primarily due to a fall in prices of mineral oils, food products
| Photo Credit: Reuters

India’s wholesale prices remained in deflationary territory for the third successive month in June, with the pace of price contraction from a year ago quickening to -4.12% from -3.48% in May.

This is the sharpest contraction in wholesale prices in about eight years, and was largely aided by the base effects from last June when wholesale price inflation was 16.2%, and some deceleration in commodity prices.

Some food items such as milk, cereals, pulses and wheat, reported high inflation rates in the range of 8%-9%. Vegetables reported 22% deflation year-on-year, but prices were up 13.2% in June, when compared to May.

While fuel and power inflation rate skidded to -12.6% in June from -9.2% in May, the dip in prices in other categories was milder, with the Food Index down just 1.2% compared to -1.6% in May. Sequentially, however, wholesale food prices were up 1.4% from May.

Deflation in primary articles’ prices moved to -2.9% from -1.8% in May, but their prices inched up 0.6% from May. Manufactured products’ prices fell 2.7% from last June and 0.5% from May 2023 levels.

The Commerce and Industry Ministry said the decline in the inflation rate in June is primarily due to a fall in prices of mineral oils, food products, basic metals, crude petroleum & natural gas and textiles. The ministry also revised upward the inflation rate for April 2023 to -0.79% from -0.90% estimated earlier.

Rating firm ICRA reckoned that the deflation in the WPI will ease to 2%-2.5% in July with global commodity prices seeing a sequential rise of 1.2% so far this month. The surge in prices of vegetables, with a “moderate hardening in cereals and pulses” due to supply disruptions amid excess rainfall, along with the lag in sowing of major crops and the onset of El Nino conditions impart uncertainty to the food inflation outlook, it noted.

“The moderation in food inflation in year-on-year terms masks the sequential price rise: The month-on-month increase in food prices was similar to that seen in retail inflation data for June,” said a research note by Barclays’ analysts, which said food prices surged across the board in June, except in the case of fruits and oilseeds.

The gap between retail inflation, which hit a three-month high of 4.8% in June, and wholesale inflation has now widened to 893 basis points, the highest since June 2022, and economists expect the deflation in wholesale prices to help moderate retail prices with a lag.

One basis point equals 0.01%.

Vegetables on sale at Azadpur Mandi in New Delhi on July 12, 2023.
| Photo Credit: PTI

India’s retail inflation hardened in June to a three-month high of 4.81% from 4.31% in May, driven by a spike in food price inflation to 4.5% from less than 3% in the previous month, owing to rising costs faced by households for items like cereals, pulses, milk and tomatoes.

While the pace of consumer price rise in June broke a four-month streak of moderation from the 6.5% uptick recorded this January, urban consumers faced nearly 5% inflation in June with food price inflation nearly doubling from May’s 2.4% level to 4.3% last month.

June marked the fourth month in a row that retail inflation has stayed below the Reserve Bank of India’s (RBI’s) upper tolerance threshold of 6% for consumer price rise, but economists believe the ongoing upturn in vegetable prices and the “flooding plus uneven monsoon” situation in the country could exacerbate food price pressures on headline inflation.

Also read: Data | Parsing the inflation story of the past year

While the central bank is unlikely to shift from its hawkish ‘pause’ on interest rates at next month’s monetary policy review, this trend may push the prospect of rate cuts further into the horizon.

“The spike in vegetable prices is set to push the retail inflation to an uncomfortable 5.3-5.5% in July,” said Aditi Nayar, chief economist at rating firm ICRA, who believes the vegetable price shock could result in an overshooting of the 5.2% average retail inflation projected by the RBI’s Monetary Policy Committee for the July to September quarter.

Vegetables, in fact, remained in disinflation territory in June but only just, with prices just 0.1% lower than a year ago, compared to 8% lower year-on-year in May.

The “tomato shock” would mean vegetable price inflation would resurge sharply this month, while cereals and pulses will also remain under pressure as the area under irrigation is lower so far this year, cautioned Bank of Baroda chief economist Madan Sabnavis.

June’s Consumer Price Index surge comes on top of the 7% inflation recorded in the same month last year, when the Consumer Food Price Index had climbed 7.75%. Despite the high base, cereals recorded an inflation of 12.7% this June, breaking a three-month streak of moderating prices. Spices recorded a sharp 19.2% inflation in June, while pulses prices rose 10.5%, milk by 8.6% and eggs by 7%.

Edible oil prices, which had shot up after the Russia-Ukraine conflict broke out last year, helped cool the overall food inflation print, recording an 18.1% drop in prices from June 2022 levels.

Among the 22 major States, 13 recorded an inflation rate below the national average of 4.8% in June, but four States recorded 6%-plus inflation, led by Tamil Nadu (6.41%), and followed by Uttarakhand (6.32%), Bihar (6.16%) and Haryana (6.1%).

“The path ahead looks grim given the progress of monsoon and the spread across key areas in the Deccan Plateau region,” Mr. Sabnavis noted. Crisil chief economist Dharmakirti Joshi underlined that July and August are critical months for agriculture. “We will wait to watch how rains pan out,” he concluded.