Budget 2024-25: Steady progress on inflation, but next steps are crucial

"Food inflation has a large bearing on headline inflation, given its high weight of 48.6 percent in the CPI," said Morgan Stanley economists in their 2024 outlook for India.

"Indeed, since the pandemic, food inflation volatility has increased, averaging 6.4 percent between 2020-2023 year-to-date, versus an average of 3.6 percent in the preceding 5 years… As such, supply-side shocks have had a larger impact on headline inflation post pandemic," they added.

The upcoming budget, then, will be key in designing measures that can smoothen the supply of key food items, which will in turn reduce volatility in food inflation and take India's inflation management to the next level.

The big hits

1) First things first: the flexible inflation targeting framework — based on which the Reserve Bank of India (RBI) must adjust its monetary policy to meet the dual mandate of price stability and growth — has undoubtedly lowered retail inflation in India. From nearly 11 percent in early 2012, Consumer Price Index (CPI) inflation quickly fell to 6.7 percent in 2014, before averaging 4 percent or lower in 2017, 2018, and 2019.

Of course, the pandemic and the Russia-Ukraine war meant inflation rose above 6 percent in 2020 and 2022, but the course is being corrected. Inflation has hovered between 4 and 6 percent for most of 2023. Compared to a developed economy such as the US — where inflation has been much higher than the target — that is fairly good, as reflected in the fact that the RBI has had to raise the repo rate by only 250 basis points. In contrast, the US Federal Reserve has increased its interest rates by more than 500 basis points since the lows of the pandemic.

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2) Inflation, like many other economic forces, depends on what households and other economic agents expect. This makes it crucial for the flexible inflation targeting framework to be credible. And while successful, any failures must be acknowledged. As such, the RBI's admission of failure in late 2022 was important. While the details of the 'letter' it sent to the government remain under wraps, the central bank's corrective action has been visible.

3) Perhaps the biggest gain has been team spirit. The government and the RBI have worked together to manage inflation, with the central bank advising the Centre on some of the supply-side measures that need to be taken to cool prices of food items.

"Since the government and the central bank each can help achieve the other's objective, coordination can give the best results," Ashima Goyal, one of the three external members on the Monetary Policy Committee (MPC), said in a paper in November 2023.

Also Read: Trade measures can ease food inflation only in short run, says MPC's Shashanka Bhide

This bonhomie is in stark contrast to the years under the governorship of Raghuram Rajan and Urjit Patel, when the relationship between Mint Street and North Block was only on paper. The result of this close coordination has been a series of steps taken by the government to help control food inflation — ranging from export bans and duties to changes in stocking limits, among others — with the RBI communicating its suggestions to New Delhi at regular intervals.

The big misses

1) The RBI is deemed to have failed when average CPI inflation is outside the 2-6 percent tolerance range for three consecutive quarters. But the range is not the target; 4 percent is. And inflation has been above target for 50 consecutive months now. It is expected to spend another couple of quarters above that level, before briefly falling to sub-4 percent — due to a favourable base effect — in the middle of 2024-25. It is not for nothing that the MPC is so focussed on bringing inflation down to the target on a sustained basis.

Also Read: All price-setting bodies should internalise 4% inflation target, says MPC's Ashima Goyal

"As of now, we are forecasting the July 2024 CPI inflation at 2.8 percent and August 2024 at 3.5 percent. Given that monetary policy is forward looking, the MPC can consider embarking on a rate cut cycle from June 2024, if the inflation trajectory plays out the way we expect," said Kaushik Das, Deutsche Bank's chief economist for India and south Asia.

2) According to RBI Governor Shaktikanta Das, the headline inflation rate is "vulnerable to recurring and overlapping food price shocks". This makes solving the food inflation problem a policy imperative — something the RBI has pointed out.

"The vulnerability of the economy to recurring vegetable price shocks, especially ahead of and during the monsoon, warrants major reforms in perishable supply chains," the central bank said in its State of the Economy article in August 2023. With climate-related events impacting agricultural output severely, it would be a surprise if the upcoming budget does not act on this front.

3) A more long-term puzzle is the CPI itself, which is widely seen as being outdated. The statistics ministry is currently conducting the second of its back-to-back consumer expenditure surveys (CES). Once complete, the process of updating the CPI's basket of items and other related issues mean it could take until 2026 for India to get an updated retail inflation series. Currently, prices of items as obsolete as VCR players and tape recorders are collected to measure India's inflation rate.

Also Read: Statistics ministry mulling back-up plan to update CPI if consumer survey junked again

Why is an up-to-date CPI basket important? Because monetary policy, which is forward looking, is heavily determined by inflation forecasts.

"Timely base revision with synchronous CES, price, and market survey every five years can address policy makers' concerns," RBI economists had said in March 2023.