Food for monetary thought

Acentral bank's role doesn't stop with controlling inflation; it also extends to anchoring inflationary expectations. For the Reserve Bank of India (RBI), the latter has been rendered especially difficult, thanks to soaring food prices, against which the standard monetary policy tools are largely ineffective. Annual wholesale food inflation in September ruled at 18.4 per cent; it averaged 12 per cent over the last five years. Given that food comprises roughly 40 per cent of the average consumption expenditure, prices of rice, milk and onions matter more in the formation of inflationary expectations than such things as steel, cement and polyester staple fibre. To the extent food prices have a predominant influence in determining the inflation rate in ‘people’s minds’ — and are factored into wage bargains, among other things — the RBI has reasons to worry.

But the problem is there is little that higher repo rates or increased cash reserve requirements can do to bring down food prices. The RBI, to labour the obvious, can also do nothing about the prolonged monsoon — in contrast to last year’s deficient rains — that has led potato prices shoot up by 50 per cent in a month. The central bank can at best only prevent food price increases and the resultant inflationary expectations from spilling over into generalised inflation. Such transmission, through the familiar wage-price spiral, was probably happening until about a year ago. But that’s no longer the case, going by the ‘core’ inflation rate. This number, which excludes inflation in food and fuel items, has fallen to just over 2 per cent in September from 5.7 per cent in the same month last year. The drop can, indeed, be attributed to the RBI’s monetary tightening measures: High interest rates, by contributing to an economic slowdown, have vastly reduced pricing power of corporates. They aren’t in a position today to pass on cost increases. Anecdotal evidence of rising layoffs and stagnant or low salary increases indicates a limited pass-through of food inflation to wages as well.

Preventing a spillover of food inflation in the long run is, however, not possible. Factory closures and unemployment cannot be solutions to a problem primarily rooted in supply-side constraints. True, the blame for not doing enough to boost crop yields or reform India’s antiquated agricultural marketing systems lies largely with the Centre. But does that mean we should persist with tight money policies until the farm economy improves? One hopes RBI Governor Raghuram Rajan will show the same pragmatism he has demonstrated so far in not going for a repo rate hike in Tuesday’s Monetary Policy review. Signalling higher interest rates now will only worsen the ongoing slowdown and investor sentiment. Also, it Is hardly going to help reduce vegetable prices. This is best left to be sorted out by other means.

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