India's inflation targeting framework needs a relook, suggests Economic Survey

Chief Economic Adviser V Anantha Nageswaran

The Indian central bank should explore an inflation-targetted framework that excludes the volatile food component, advocates the Economic Survey for 2023-24.

"Higher food prices are, more often, not demand-induced but supply-induced. Short-run monetary policy tools are meant to counteract price pressures arising out of excess aggregate demand growth. Deploying them to deal with inflation caused by supply constraints may be counterproductive," noted the survey presented on July 22.

The the Reserve Bank of India targets a consumer price index (CPI)-based inflation with a mandate of keeping the rate at 4 percent along with a tolerance band of 2 percentage points on either side.

The survey added that since hardships caused by higher food prices for poor and low-income consumers can be handled through direct benefit transfers or coupons for specified purchases valid for appropriate durations, the Monetary Policy Committee can consider targeting an inflation rate that excludes food.

These comments come at a time when India’s retail inflation hit a four-month high of 5.08 percent in June, compared with 4.75 percent in the previous month, as food inflation galloped to 9.4 percent following a surge in the prices of vegetables.

June marked the eighth consecutive month of over 8 percent food inflation.

The survey further explained that since food constitutes a very high portion of the consumer price index in developing countries, when central banks in these nations target headline inflation, they effectively target food prices.

"So, when food prices rise, inflation targets come under threat. Therefore, the central bank appeals to the government to bring down the increase in the prices of food products. That prevents farmers from benefiting from the rise in terms of trade in their favour," it said.

This is not the first time the topic of a review of India's inflation targeting framework has come up. In fact, many experts have in the past highlighted the merits of aiming for core inflation, instead, which comes without the volatile food and fuel components.

India's Core CPI held steady at 3.1 percent in June.