Why is food inflation still haunting us?

A Srija/Shreya Bajaj | Updated on June 20, 2021

Food price worries   -  SUSHIL KUMAR VERMA

Elevated food prices pose a dilemma for both monetary and trade policies. Tariffs may be a better option than quotas

CPI inflation has remained at an elevated level in 2020-21, which has prompted both the government and the RBI to intervene in the market. However, inflation continues to be sticky.

Much of this increase in CPI has been attributed to food inflation. Consumer Food Price Index (CFPI), 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 is mainly attributed to vegetables in the initial months and to pulses and edible oils in the latter part of the year.

Policy dilemmas

Food inflation is a cause for concern for obvious ethical reasons. But it also presents a policy dilemma for the government and 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 per cent tolerance band. Inflation above 6 per cent for three consecutive quarters supports the case for a tight monetary policy.

However, a tight monetary policy may have a role in managing inflation if it is driven by excess demand. But, the current spike in CPI inflation is driven by food inflation which is mainly a supply-side phenomenon, hence, restraining the role of monetary policy in curtailing it. The possibility of strong secondary effects from food inflation to core components was also ruled out in Economic Survey 2019-20.

However, if 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.

A rise in food inflation poses a dilemma for trade policy too. In case of pulses inflation, it’s usually a fluctuating trend with peaks and troughs, indicating presence of cobweb phenomenon i.e. farmers’ production decision in year ‘t’ is highly influenced by prices that prevailed in year ‘t-1’.

While the underlying problems of inadequate storage and food processing facilities in the food chain further adds to the cobweb phenomenon, the reactive trade policy is the elephant in the room. Pulses production in India is rainfed, subject to vagaries of nature, hence, maintaining stability in trade policy is difficult. However, stable trade policy has its merits and government needs to find a balance to ensure maximum welfare.

During periods of bumper harvest, prices are low, so import restrictions are put in place and when production is low, export curbs are imposed. This leads to uncertainty and distorts the market signals for producers.

Further, the import quotas and tariffs set are based on ad-hoc criteria and there is no scientific assessment done to assess the actual demand. Also after quotas are set, import permit distribution gets delayed and by the time imports actually reach India, prices are already inching down due to arrival of new harvest in the market.

The instability in import policy also creates uncertainty for the exporting countries whose production levels depend on India’s import orders. India being a big consumer , a last-minute entry in the international market pushes the per unit import price substantially and reflects in the domestic prices.

There should be consistency in import policy as that sends appropriate market signals in advance. Intervening through import tariffs is better than quotas which leads to 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 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 RBI to better target the non-volatile segment (core inflation).

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

Published on June 20, 2021

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