1. Proposal Overview

• Economic Survey Suggestion:The Economic Survey proposes that food prices be excluded from the inflation target managed by the Reserve Bank of India (RBI). This would involve focusing on ‘core’ inflation, which excludes food and fuel prices, rather than ‘headline’ inflation that includes all components.
• Current Practice:Presently, RBI targets headline inflation, which includes food prices, as part of its mandate to control inflation.

2. Food Price Inflation Trends

• Historical Context:
  • Recent Inflation Rates:As of June, food price inflation was around 10%, reflecting a significant increase compared to historical averages.
  • Persistent High Rates:Food price inflation has been high since 2019, and this trend predates both the COVID-19 pandemic and the Ukraine war, indicating domestic factors are at play.
• Consumer Price Index (CPI) Impact:Food constitutes a significant portion of the CPI in India (about 50%), leading to a considerable impact on overall inflation rates.

3. Inflation Targeting by RBI

• RBI’s Mandate:Since 2016, the RBI has been tasked with controlling inflation through monetary policy, primarily by adjusting interest rates.
• Target Achievement:The RBI has failed to meet its 4% inflation target in each of the last five years. This performance aligns with global trends where central banks have also struggled with inflation targets.
• Global Comparison:
  • Bank of England:Has had inconsistent success with inflation targeting.
  • Federal Reserve (US):Aimed for 2% inflation but faced over 8% in 2022 before returning to near-target levels.

4. Arguments for Excluding Food Prices

• High Food Expenditure:
  • Indian Context:Food accounts for approximately 50% of household expenditure in India, a high proportion compared to other countries like the US (less than 10%).
  • Economic Implication:Ignoring food prices may overlook the impact on a significant portion of the population, affecting their cost of living and economic well-being.
• Transitory Nature of Food Prices:The argument that food price fluctuations are temporary and self-correcting does not hold in the Indian context, where food price inflation has been consistently high over the years.

5. Effectiveness of Targeting Core Inflation

• Historical Performance:
  • Core Inflation Trends:Core inflation (excluding food and fuel) has only been within the target range in one out of the past 13 years.
  • Monetary Policy Effects:Raising interest rates, intended to control inflation, often leads to increased costs for firms, potentially raising prices and exacerbating core inflation.
• Food Prices as a Determinant:Food prices influence core inflation through their effects on wages and production costs, making it challenging to control core inflation independently of food prices.

6. Ideological and Policy Considerations

• Global Policy Shifts:
  • Post-Soviet Economic Models:The global shift towards market-driven production and central bank-managed inflation control arose after the collapse of the Soviet Union. This model may not be fully appropriate for the Indian economic context.
  • Indian Policy Practices:India’s adherence to global inflation targeting practices might be less suited to its unique economic conditions, particularly the high weight of food in CPI.
• Policy Relevance:The proposal to exclude food prices from inflation targets could be seen as adopting practices that may not address the specific inflationary challenges faced by India.

7. Recommended Policy Focus

• Supply-Side Measures:
  • Agricultural Productivity:The key to managing food price inflation lies in improving agricultural yields and controlling production costs.
  • Strategic Approaches:Addressing issues in agriculture through comprehensive strategies could stabilize food prices and, by extension, overall inflation.
• Income Transfers:
  • Budget Constraints:While income transfers might help mitigate some of the adverse effects of rising food prices, they could strain the Budget if food prices continue to rise faster than overall inflation.
  • Public Goods Impact:Increased spending on transfers could reduce funds available for public goods and infrastructure.

Conclusion

The Economic Survey’s suggestion to exclude food prices from inflation targeting reflects a broader debate on effective inflation control. Given the high weight of food prices in India’s CPI and their impact on core inflation, a more viable solution involves focusing on improving agricultural productivity and directly managing food price inflation. Altering inflation targeting frameworks without addressing underlying supply-side issues could leave India vulnerable to persistent inflationary pressures.