That the Monetary Policy Committee (MPC) of the RBI will keep the policy rate as well as the stance unchanged for the ninth consecutive time was a foregone conclusion, if the results of the surveys conducted earlier were any indication. An added factor that ruled out any policy-easing or any forward guidance in this regard was the recent downward pressure on the rupee and a host of other emerging-market currencies in the wake of the unwinding of global carry trades.

Reportedly, the RBI has intervened repeatedly in the forex market in the recent weeks with some success in the sense that the rupee has remained less volatile compared to its peers even as it is close to the psychologically important level of ₹84 to a dollar. The external sector considerations on the timing of the next monetary policy pivot are quite significant now. And, plainly speaking, the RBI cannot afford to commence policy easing in this cycle before the Federal Reserve does so.

Headline versus core

The RBI has reiterated its commitment to aligning inflation to the target of 4 per cent on a durable basis. Alongside, it has forthrightly emphasised a long-held truism in monetary economics that ensuring price stability would strengthen the foundations for a sustained period of high growth. And as far as the RBI and all other central banks having inflation-targeting mandates are concerned, inflation means headline CPI inflation. And the RBI, like its peers, monitors other measures of inflation, chief of which is core inflation — that is, CPI inflation excluding food and energy prices. The distinguishing feature of food and energy prices is that they are driven by supply-side forces as opposed to the items that figure in the core component whose prices are more sensitive to the aggregate demand in the economy.

Following the release of the Economic Survey 2023-24 last month, a debate has ensued on whether the RBI should base its policy decisions exclusively on the performance of headline CPI inflation vis-à-vis the target of 4 per cent or it should also take into account the trajectory of core CPI inflation. The trigger for the debate is the inclusion of a rather rueful observation in the Survey: ‘Despite the core inflation rate being around 3 per cent, the RBI, with one eye on the withdrawal of accommodation and another on the US Fed, has kept interest rates unchanged for quite some time, and the anticipated easing has been delayed.’ Subsequently, there were reported suggestions to the effect that the monetary policy is a short-run macro aggregate demand management tool, which cannot manage aggregate supply shock and food shocks are predominantly supply shocks. The hint here appears to be that food inflation should be kept out of the purview of monetary management.

This line of thinking, including its variants and offshoots are nothing new. Those who were not and still not in favour of inflation-targeting have always put forth a view that inflation in India is pre-dominantly a supply-side phenomenon and monetary policy responses against episodes of high inflation will only harm output and employment without making any dent thereon. An earlier but less sophisticated point of view which was popular among policymakers and commentators alike till the onset of structural reforms in the early 1990s was that money-printing for financing fiscal deficits was kosher, with no significant adverse implications for inflation, so long as the RBI was able to control its secondary impacts.

To be sure, core inflation in India has declined sharply from a high of 7.1 per cent in June 2022 to a historic low of 3.1 per cent in June 2024. It would, therefore, be fair to say that monetary tightening by a cumulative 250 basis points between May 2022 and February 2023 has had a visible impact in curbing core inflation. In the Indian context, food prices have been the real driving force of non-core inflation, since energy prices have actually fallen during this period. However, food inflation has been stubbornly high: it actually rose from 4.6 per cent in June 2023 to 9.4 per cent in June 2024. Average food inflation rose from 3.8 per cent in FY 2021-22 to 6.6 per cent in FY 2022-23 and further to 7.5 per cent in FY 2023-24. Consequently, the fall in headline inflation has been slow and uneven: in fact, it rose to 5.1 per cent in June 2024 from 4.9 per cent a year earlier.

Rising vulnerability

Like in many parts of the globe, there is clear evidence indicating rising vulnerability of food prices in India to climate change — heat waves, uneven spatial and temporal distribution of monsoons, unseasonal rainfall, hailstorms, excessive rainfall and prolonged dry conditions.

A high-quality research paper by the RBI in January 2024 provided valuable insights on major issues relating to the implications of food inflation for monetary policy-making in India. The major takeaways from this research are: (a) in general, food price shocks are transitory in nature, (b) spillovers do happen from food prices to non-food prices, particularly when food price shocks are large and persistent, and (c) the significance of food price spillovers underscores the importance of anchoring inflation expectations in the wake of persistent and large food price shocks.

More analysis would be needed to determine whether the current spurt in food price inflation is transient or not. However, in such issues, it is better for a central bank like the RBI to err on the side of caution than to rush to a convenient conclusion. The weightage of food inflation in the headline inflation which is currently about 46 per cent is expected to decrease by about 4-5 percentage points on the completion of the household expenditure survey that is now being conducted. The proportion of income of rural household that is being spent on food items is still high, as a result of which food inflation is a gauge for headline inflation in rural areas. Hence, there is no case for dilution of the inflation-targeting framework that has been in place since 2016.

Apparently, there are deeper factors at work behind this debate. The inflation-targeting framework altered the ‘political’ equation between the RBI and the Finance Ministry because it significantly reduced the scope of fiscal dominance over monetary policy-framing. If the abolition of the mechanism of ‘Ad hoc Treasury Bills’ in the early 1990s was the first step in this direction, inflation-targeting was a real game-changer. But that does not mean that demand for tactical fiscal space with reduced cost of borrowing and higher growth in output and employment in the short-term will not be made.

The writer is a former central banker and a consultant to the IMF. Through The Billion Press

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