In September, inflation spiked to 6.2%, driven entirely by rising food prices. However, despite that, Commerce Minister Piyush Goyal called for a re-evaluation of the framework and a possible rate cut.
Finance Minister Nirmala Sitharaman also echoed the need for broader discussions on inflation and interest rate dynamics.
To delve deeper into this issue, CNBC-TV18 engaged with leading experts—Professor Pulapre Balakrishnan from the Centre for Development Studies, Sonal Varma, Chief Asia Economist at Nomura, and Rupa Rege Nitsure, former Chief Economist of BFSI—to explore the implications and potential paths forward.
Edited Excerpts:
Q: Has this demand got anything to do with the academic debate on whether food should be included in the target? This appears to be that the government is worried, the second quarter was bad, we had poor IIP numbers and core sector numbers, and even Nifty earnings growth was just in single digits, so they’re just passing the buck to the Reserve Bank. Is that what we are witnessing now?
Varma: It’s possible that the current trade-offs are so stark that we are having this debate, but it’s good to have this debate because we could face shocks on both sides. There could be a scenario where food inflation is actually very low, but core inflation is much higher. And then the debate actually would be, do interest rates need to be cut at all, or should we be hiking rates? So I think we do need a fundamental debate about what is the right metric to target.
I stand on the side that we cannot just exclude 40% odd of the CPI basket at all. We know that food impacts expectations, etc. But food is a very broad, comprehensive basket. Within food, you have certain items which are very volatile, and other items which are more persistent.
Q: Do you think that we can look through or the MPC must look through the current food increase? Core inflation has ranged between 3% and 3.7% in the entire calendar 2024, and it is only food that has taken the headline CPI above 6%. Can the Reserve Bank and the MPC, or should the Reserve Bank and the MPC look through this food inflation?
Balakrishnan: We should start with an idea of what our inflation index should be, what it should contain, what goods. And from that point of view, there is no question of keeping food out of it, the question doesn’t arise.
You said that in 2016, or whenever the RBI decided to target headline inflation, ie, an index with food, it was not just the RBI, but the RBI in agreement with the government of India. Now, strangely enough, the government of India seems to want food out of it, which I think is not quite correct since inflation targeting with the existing index of inflation has been renewed in 2021 after five years of the first round.
The final thing I want to say now is whether food inflation is in the target or not, or food prices are in the inflation index, and food inflation will impact growth. There’s no question about it, and that’s clearly something which the government is worried about I would think.
The industrial growth, or manufacturing growth in the last year was down to 5% from about 8% or 9%, and there’s every reason to believe that that’s due to high food price inflation, which leaves less with households to spend on non-food items.
Q: Has the RBI used the word flexible very well? It did look through the high food inflation during the COVID years. So, where it is entirely supply-driven, they are looking through it and therefore, right now, do you think there is any need to change the system?
Nitsure: I fully agree with you that it is flexible inflation targeting, and ~2% gives enough margin or scope for the Reserve Bank of India to adjust for stressful episodes. But when we are talking about headline CPI inflation as the nominal anchor of monetary policy, almost 44% of the weightage comes from food inflation and food articles, and that is very much part of the cost of living, these are linked to wages, labour market costs, and eventually it impacts inflationary expectations and through that generalised inflation. So, there is no question of removing food inflation from the overall inflation index, which is being used as a nominal anchor for monetary policy.
Q: There is a slowdown. You were the one who was calling the slowdown, probably earlier than the others, and now you know, we’ve seen that softness in the second quarter. If there is a gentleman’s agreement between the government and Reserve Bank that we will be in charge of food if the government were to say we will ensure that the supplies are monitored or made available, you worry about the rest of the economy, and therefore you cut rates, because, after all, there is a problem. There is a softness in industrial growth. Core inflation is down to under 4%, which is the RBI’s mandate. Would that be a fair argument? We’ll take charge of food; you take charge of the rest?
Varma: So I think the arguments that are being made right now by the government are actually fair, in my view. So if you look at 95% of the CPI basket, which is ex-vegetables, it is running below 4%, and it’s been below 4% actually, for most of 2024, so this is not a broad-based increase. In fact, if you look at the roughly 300-odd items in the CPI basket, about 70% of the items have an inflation rate that is less than or equal to 4%. So, it is not broad-based.
Second, the entire argument about it’s leading to second-round effects, whether you look at rural wages, urban wage growth, inflation expectations, households, inflation expectations from businesses, none of that actually suggests there’s been any spillover. In fact, the mean measures of inflation have been, again, below 4% for quite a long time.
And third, I think the growth sacrifice is on the rise. Monetary policy needs to be forward-looking. What we’ve seen so far in the first half of FY25 is clearly an undershoot on growth. I think the current assumption we are making is that this is transitory and government spending picks up, agriculture is great, and the second half is going to somehow see a recovery. We need to realise that we are keeping monetary policy tight when the broader inflation is under control and simultaneously tightening macroprudential policies. So, when you have the combination of the tight monetary and credit policy in this inflation backdrop, I think the growth sacrifice is much higher than is being acknowledged right now. So, it is, at the end of the day, flexible inflation targeting. So, are we being flexible?
Q: Would you have a different point of view? There is a sizable body of economists who believe that growth has slowed precisely because of these other reasons that Sonal mentioned — extraordinary heat, monsoons being very high in some places, and the government not spending enough, that is a big reason. Reserve Bank’s earlier liquidity tightening for another reason altogether last year, the withdrawal of notes, etc, there is a very clear expectation that now, as the fisc spends and the Reserve Bank has already made liquidity almost surplus in the interbank system, growth will pick up, and therefore you should not tinker with rates when the mandate given to you is 4% headline inflation, your thoughts?
Balakrishnan: I would say, once again, it is not in the fitness of things that once a mandate has been given to the Reserve Bank. And let me tell you. I say this as somebody who’s quite sceptical about the Reserve Bank’s ability to control inflation, and I’ve done quite a bit of work on this, but I believe that once the mandate has been given, you should allow them to get on with the job.
Having said that, I would say that I don’t particularly look at the economy quarter to quarter, but I’d just like to say in the last year, the provisional GDP estimate is 8.2% which is extraordinarily high by historic standards. Government should be more concerned with inflation control now, rather than be particularly concerned about growth and that inflation control will require control of food prices. RBI has a very little role in this. And I just want to say a final thing, as much as you said about letting the RBI control core inflation. My work basically shows, and this is published, my work shows that RBI’s attempt to control even core inflation is not very successful. And there’s a very simple explanation of that. When you raise interest rates, firms with market power will pass it on as higher costs, and the impact of interest rates on even core inflation is not very high.
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