A working study under the Reserve Bank of India (RBI) suggests that ignoring persistent food costs may have an unwanted impact on the policy rate structure of India, amidst increasing demands to revise the inflation-targeting framework of the central bank. As the food prices in India can be pretty rigid, if only the core prices are considered, irrespective of the maximum retail price, then the inflation rate will be under-predicted.
A paper published by the RBI shows how sticky food prices can be in India, as they vary from just over one month to even four months in certain cases. When the researchers and market experts only target the core prices, they do not include the volatile food and fuel costs, ultimately leaving out the retail price and this process can carry the risk of under-predicting inflation and thus, lead to lower than required changes in the interest rate and vice-versa.
Current trends in the RBI
The Reserve Bank of India currently targets headline consumer price inflation, with a compulsory rule to keep the prices within a 2%-6% target range, mostly at the 4% midpoint. Recently, food prices have grown higher and have driven the headline number way beyond RBI’s tolerance limit. This is forcing the policymakers to halt the interest-rate cuts last month after easing of 115 basis points this year. GV Nadhanael, an assistant adviser in the Economic and Policy research department of RBI, said, “The bottom line is that macroeconomic models have to explicitly account for sticky component of food prices in this environment.” He added, “Stubborn food prices do not ‘perfectly align’ with the conventional measure of underlying inflation.”
Other economists speak
Currently, the food industry accounts for 46% of India’s CPI, and thus, it is one of the highest inflation-targeting countries. Several economists, including Abhishek Gupta from Bloomberg Economics, argue that the RBI should target core prices now as the headline inflation measure being currently used is too volatile and dynamic. He published an article in Bloomberg that said, “This dichotomy implies that focusing only on inflation excluding food and fuel as a measure of underlying inflation entails the risk of policy errors.”
The Policy Times Suggestions
- As suggested by many economists, it is now time to focus on the core prices of food products as well.
- All policy errors must be rectified so that the underlying inflation can be noted and required measures can be taken.
- In addition, the economic policies by the central government are not proving beneficial enough to deal with the coronavirus pandemic. Immediate action needs to be taken to deal with the repercussions or else, India will witness unforeseen losses, currently speculated by several economic experts.
- Steps must be taken to revise the policies of the central bank and the inflation-targeting framework.