India’s CPI needs an urgent shake-up. Image: Bloomberg
One of India’s problems is that even as it grows richer, it has a hard time changing its policies to adapt to that change. Economic frameworks designed for when it was a much poorer country restrict and limit growth. This is particularly true when it comes to food prices and monetary policy.
Bloomberg News recently reported that authorities may restructure the way the government measures price increases. That would offer a chance to break out of the straitjacket that has locked it into growth; bureaucratic conservatism should not cause India to miss out on this opportunity.
Unfortunately, officials are reluctant to touch on anything related to food production and prices, as they are particularly politically sensitive issues. But they are now becoming absurdly outdated. India’s agricultural subsidy framework, for example, was designed in the 1960s to boost domestic grain production. That may have been appropriate for a postcolonial nation subject to mass starvation, but it is not appropriate for an industrializing nation with food surpluses that needs stable prices for vegetables.
Policymakers face a version of this dilemma when it comes to monetary targeting. About a decade ago, the Reserve Bank of India was given a formal mandate to target inflation at 4%. Since then, the country, once subject to significant inflation fears, has managed to keep prices under control. This was underlined earlier this week when the consumer price index for July was released, which showed inflation was below the RBI’s target and at its lowest since before the pandemic. Understandably, few want to mess with a system that appears to be working.
But it may be necessary. The government’s chief economist argued in his main monetary policy document last month that it makes sense for food prices to be left out of the central bank’s inflation target.
His argument was simple but persuasive: monetary policy cannot solve supply problems, but is meant to address short-term problems related to aggregate demand. But food prices in India respond to various rigidities in the economy that affect the supply side alone. Grain prices depend on how much the government must pay farmers. Supply chains for vegetables and proteins are fragmented, causing prices to swing wildly in response to temporary availability and transportation problems. So the chief economist’s argument makes some sense.
The costs of ignoring its reasoning are high. Because it targets an inflation index that includes volatile food prices, the RBI consistently keeps rates high for longer than necessary. Core inflation (excluding food and fuel) has been well below the 4 percent rate for some time. But the central bank has not cut rates, because Indian food prices have been higher than those of global peers. In recent weeks, food inflation has eased not thanks to any change in policy or demand, but simply because the summer heatwave has subsided.
Still, we will probably have to wait a few more months for the central bank to respond. The RBI’s rate-setting committee has met nine times in a row without any cuts. Every week that an economy deprived of funds to invest has to endure a higher-than-necessary real interest rate can be measured in losses of profits, growth and employment.
The argument against change is equally simple: as long as food prices affect Indians’ future inflation expectations, they cannot be excluded from the RBI’s calculation. This is essentially what the central bank governor insisted on last week. He is concerned that the RBI’s credibility depends on its response to the overall price level, not just underlying inflation. This is also true.
But the governor also made a fatally flawed assumption: that India’s consumer price index, and thus his mandate, heavily weights food prices. In fact, the index, based on surveys conducted in 2011-2012, overweights food, which makes up 45 percent of the household basket. Like the agricultural policy, its composition reflects the idea that India is little more than a subsistence economy. With each passing year, that view grows more outdated.
India’s CPI is indeed in urgent need of an overhaul. Many of the developing countries that have inflation targets do better than we do. For example, Indonesia has similar problems when it comes to volatile food prices, but food also has a much smaller weight in that country’s CPI. More importantly, that weight is constantly revised to reflect reality; every few years, its statisticians analyse actual household consumption in hundreds of cities and towns and reweight the index accordingly. This is certainly not asking too much of its counterparts in New Delhi and Bombay.
If we don’t, India will continue to have a central bank that uses monetary policy to set a price index over which it has no control. Is it any wonder that the Reserve Bank of India consistently lags behind?
Disclaimer: This is a Bloomberg opinion piece and these are the personal views of the author. They do not reflect the views of www.business-standard.com or the Business Standard newspaper
First published: August 19, 2024 | 7:52 a.m. IS
Disclaimer:
The information contained in this post is for general information purposes only. We make no representations or warranties of any kind, express or implied, about the completeness, accuracy, reliability, suitability or availability with respect to the website or the information, products, services, or related graphics contained on the post for any purpose.
We respect the intellectual property rights of content creators. If you are the owner of any material featured on our website and have concerns about its use, please contact us. We are committed to addressing any copyright issues promptly and will remove any material within 2 days of receiving a request from the rightful owner.