Mentor comment: Food inflation in India significantly impacts the economy, particularly affecting low-income households that spend over 50% of their income on food. High food prices can lead to increased overall inflation, influencing wage demands and inflation expectations. This creates second-round effects, where rising food costs contribute to broader inflationary pressures. The persistence of food inflation complicates monetary policy, as the Reserve Bank of India struggles to control inflation without directly addressing food prices, which are influenced by supply-side factors beyond its control. Thus, food inflation remains a critical challenge for economic stability.

Let’s learn!

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Why in the news? 

The Economic Survey suggests removing food prices from the RBI’s inflation target, shifting focus from headline to core inflation, and impacting inflation control strategies.

Challenges related to Food Inflation: 

1. Persistent High Food Inflation: Food price inflation in India has been elevated since 2019, with a year-on-year increase of close to 10% reported in June 2024. This trend indicates that high food inflation is not solely a consequence of external factors like the COVID-19 pandemic or the Ukraine war, but also reflects underlying domestic issues.
2. Impact on Overall Inflation: Food prices constitute a significant portion of the consumer price index (CPI), accounting for nearly 50% of household expenditure in India. This high share means that fluctuations in food prices directly influence overall inflation rates, which have been higher than usual due to persistent food price increases.
3. Food Prices as a Determinant of Core Inflation: Research indicates that food price inflation significantly affects core inflation in India. Rising food costs can lead to increased wages, which are a major component of production costs for firms. Thus, ignoring food prices in inflation targeting undermines the effectiveness of monetary policy.
4. Long-Term Food Inflation Issues: Food price inflation has not been negative in any of the past 13 years, highlighting a persistent issue in the Indian economy. food inflation is a structural problem that needs to be addressed through comprehensive economic policies.

The reason behind removing food prices from the RBI’s inflation target:

1. High Sensitivity of Food Prices: Food prices in India are highly susceptible to supply shocks, such as erratic monsoon rains and agricultural disruptions. This volatility can lead to significant fluctuations in headline inflation, making it difficult for the RBI to maintain a stable inflation target when food prices are included in the calculation.
2. Overshadow the impact of Monetary policy: Food constitutes about 46% of the Consumer Price Index (CPI) basket in India. This high weight can dilute the effectiveness of monetary policy aimed at controlling inflation, as changes in food prices can overshadow the impact of policy rate adjustments on core inflation measures.
3. Core Inflation as a More Stable Measure: By focusing on core inflation, which excludes food and energy prices, the RBI could potentially achieve a more stable and manageable inflation target. This shift is based on the premise that core inflation is less influenced by volatile food prices and can provide a clearer picture of underlying inflation trends

Way forward: 

• Strengthening Agricultural Infrastructure and Supply Chain Management: To tackle the persistent issue of high food inflation, it is crucial to invest in and strengthen agricultural infrastructure, including irrigation systems, storage facilities, and transportation networks.  
• Integrated Monetary and Fiscal Policy Approach: A more holistic approach is needed, where monetary policy is complemented by targeted fiscal interventions to manage food inflation.
  • The RBI should coordinate with the government to develop policies that address food price volatility, such as creating strategic food reserves, implementing effective buffer stock management, and providing targeted subsidies to protect vulnerable populations.