RBI members in rate-setting panel reject excluding food from inflation target

Mumbai: All three internal members of the Reserve Bank of India’s rate-setting panel harped on the need to retain food prices within the central bank’s broader inflation target, show minutes of the Monetary Policy Committee’s latest meeting on 8 August. The assertion was an apparent response to a growing chorus to exclude food from RBI’s inflation-targeting exercise.

That was the third instance this month—including RBI governor Shaktikanta Das’ speech on the day of the policy announcement, and an article by deputy governor Michael Patra in an RBI publication earlier this week—that the central bank has directly or indirectly voiced concerns against the suggestion to exclude food from its inflation target.

In July, the Economic Survey for 2023-24 suggested excluding food prices from India’s inflation-targeting framework. 

The government, as part of its inflation-targeting mechanism, had in March 2021 retained RBI’s flexible inflation target in the 2-6% band for the five years through March 2026. 

The six-member MPC has an equal number of internal and external members. The internal members include RBI governor Das, Patra, and executive director Rajiv Ranjan. The external members are Shashanka Bhide, Ashima Goyal, and Jayanth R. Varma.

Also read | Why food inflation cannot be excluded from target inflation

“The old debate of core versus headline [inflation] that was well settled when in 2016 we had adopted the flexible inflation targeting framework with headline as our target in line with international best practices has resurfaced with persistent divergence between food inflation that has remained elevated and subdued core inflation,” the MPC minutes show Ranjan as saying at the 8 August meeting.

Core inflation is headline or aggregate inflation stripped off food and fuel. Persistent food inflation has remained a concern for RBI even as core inflation has eased. 

To be sure, food inflation eased to 5.42% in July from 9.36% in June, while headline inflation dropped to a 59-month low of 3.54% in July. Food is currently assigned a 46% weight in the headline consumer price index (CPI) basket.

Second-order effects of food inflation

Mint reported on 13 August that although India’s retail inflation in July had dropped below RBI’s medium-term target of 4%, this was likely temporary due to the statistical impact of a high base.

According to Ranjan, as long as food constitutes an important segment of the consumer basket and food inflation shows signs of persistence, food could not be excluded from the CPI basket.

Patra cautioned that the gap between headline and food inflation has been widening, and as a result stalling the alignment of aggregate inflation with the target. 

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“Taking into account double digit inflation in salient food categories such as cereals, pulses, spices and vegetables for several months, empirical evidence points to a rise in the time varying persistence of food inflation, i.e., it is taking longer to revert to its trend after a shock,” Patra said during the 8 August meeting, the minutes show. 

Patra had also said that the higher trending food inflation was spilling over into the inflation expectations of households and affecting consumer confidence. 

He added that although food price shocks could originate outside the realm of monetary policy, when their effects stay in the inflation formation process “they can propagate through second-order effects and get generalized, to which monetary policy cannot be insensitive”.

No place for complacency

The current debate on excluding food from RBI’s inflation-setting framework centres around the monetary policy committee’s handicap on rising food prices, as these are caused by supply-side problems and not by demand, which can be controlled by interest rate changes.

“Persistently rising prices are always and everywhere a reflection of too much demand chasing too less supply even if it is a supply shortfall that starts the price spiral,” said Patra, adding that it was well within the bounds of monetary policy to adjust demand conditions to the state of supply.

Governor Das lauded the introduction of flexible inflation targeting in 2016 as a major structural reform and said that over the last eight years, this had gained in credibility and facilitated positive outcomes for the economy despite huge global shocks. 

“Its credibility needs to be preserved and sustained,” said Das. 

Also read | India's inflation targeting: Base it on reality and not perceptions

On 8 August, Das had said that given the high share of food in the consumption basket— 46%, food inflation pressures cannot be ignored. He had also said that the public at large understands inflation more in terms of rising food prices than the other components of headline inflation. 

“Therefore, we cannot and should not become complacent merely because core inflation has fallen considerably,” Das had said during the policy announcement. 

With a 4-2 majority, the MPC had decided to keep the repo rate unchanged at 6.5% and to retain the stance at withdrawal of accommodation. Among the members, Bhide, Ranjan, Patra and Das voted in favour, while Goyal and Varma voted to lower the repo rate by 25 basis points and to review the stance to neutral.