Stubborn food inflation

A Srija/Shreya Bajaj | Updated on April 07, 2021

Queers the pitch for monetary, trade policies

CPI inflation has remained at an elevated level in 2020-21. Rising retail inflation prompted both the government and the RBI to intervene in the market. However, inflation continues to be sticky. Much of this increase in the CPI has been attributed to food inflation.

Consumer Food Price Index (CFPI) is running in double digits since November 2019, declined steeply in December 2020 before rising again in February 2021. CFPI’s contribution in CPI-C has been hovering around 50 per cent in the current financial year. This increase in CFPI during 2020-21 is mainly attributed to vegetables in the initial months and pulses and edible oils in the latter part of the year.


A policy dilemma

Apart from the obvious ethical reasons, food inflation also presents a policy dilemma for the government and the central bank. Since 2016, India has been following the policy of inflation targeting, a CPI inflation target of 4 per cent with a plus or minus 2 percentage point tolerance band.

A tight monetary policy may have a role in managing inflation in case of excess demand driving prices. But the current spike in CPI inflation is driven by food inflation, which is mainly a supply-side phenomenon; hence, restraining the role of the monetary policy in curtailing it.

If the RBI ignores the transitory food inflation and keeps repo rates low, it might hurt inflation expectations and may be against the inflation targeting mandate. And if it increases repo rate it hurts growth, without having much impact on inflation. Hence, a greater focus on core inflation, that is more responsive to monetary policy, is warranted.

As with monetary policy, rise in food inflation also poses a dilemma for trade policy. In the case of pulses inflation, it’s usually a fluctuating trend with peaks and troughs.

While inadequate storage and food processing facilities in the food chain adds to the cobweb phenomenon (where production decision is based on prices of the previous year), the reactive trade policy is the elephant in the room.

Pulses production in India is rainfed and, therefore, subject to vagaries of nature; hence, maintaining stability in trade policy is difficult. However, a stable trade policy has its merits and the government needs to find a balance to ensure maximum welfare.

Import curbs are usually imposed in times of bumper harvests and export curbs are imposed when production is low. This leads to uncertainties and distorts the market signals for the producer.

Further, the import quotas and tariffs set are based on ad hoc criteria and there is little scientific assessment of the actual demand. In addition, after quotas are set, import permit distribution gets delayed and by the time imports actually arrive, prices begin to dip due to arrival of new stocks in the market.

The instability in import policy also creates uncertainties for the exporting countries which decide production levels depending on India’s orders. Being a big buyer, India’s last-minute entry in international market pushes the per unit import price substantially and reflects in domestic prices.

There should be consistency in import policy to help send the appropriate market signals in advance. Intervening through import tariffs is better than quotas, which cause greater welfare loss. This also calls for more accurate crop forecasts using satellite remote sensing and GIS techniques to indicate shortfall/surplus in a crop year much in advance. Moreover, a decade-old CPI base year of 2011-12 that gives nearly half of the weight to food items needs to be revised and updated to reflect better the change in food habits and lifestyle of the population.

With the rising middle-class, spending on non-food items has increased and this needs to be better reflected in the CPI, thereby enabling the RBI to better target the non-volatile segment (core inflation).

Srija is Economic Adviser and Bajaj Assistant Director in the Department of Economic Affairs, Ministry of Finance. The views expressed are personal

Published on April 07, 2021

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