RBI FACES UNCERTAINTY IN POLICY AMID RISING FOOD INFLATION

Syllabus:

GS-3: Fiscal Policy, Monetary Policy, Food Processing, Growth and development, Mobilisation of resources

Focus:

The Reserve Bank of India(RBI’s) Monetary Policy Committee (MPC) recently held its August meeting, where it decided to keep the policy rate unchanged. The meeting highlighted concerns about rising food inflation, which remains a significant factor in shaping household inflationary expectations and complicates future monetary policy decisions.

RBI FACES UNCERTAINTY IN POLICY AMID RISING FOOD INFLATION - UPSCsource:economictimes

“RBI’s Inflation Dilemma: Balancing Food Price Uncertainty”:

  • MPC’s Stance: The RBI’s Monetary Policy Committee (MPC) recently maintained its policy rate and stance, reflecting a cautious approach amidst economic uncertainties.
  • Market Expectations: While the MPC’s decisions are aligned with market expectations, there is a divergence in views on its future actions, driven by concerns over food inflation.
  • Food Inflation’s Impact: Food inflation, driven by factors beyond the RBI’s control, remains a significant concern due to its effect on household inflationary expectations.
  • Core Inflation Stability: Despite high food inflation, core inflation remains stable, staying below the RBI’s target of 4% for the last six months.
  • Future Policy Uncertainty: The unpredictability of food prices creates uncertainty in the RBI’s future policy direction, making it complex to navigate.
Key Measures of the Government to Curb Food Inflation:

  • Subsidised Commodities: The government distributes subsidised vegetables like onions and tomatoes and releases wheat and sugar stocks to stabilise prices.
  • Buffer Stock Management: Maintains essential food commodity reserves (wheat, rice, pulses) for market release during scarcity or price hikes.
  • Procurement and PDS: Expands the Public Distribution System (PDS) to ensure food security by providing subsidised grains, helping to stabilise prices.
  • Minimum Support Price (MSP): Guarantees remunerative prices to farmers, encouraging production and potentially lowering prices.
  • Import-Export Policies: Regulates imports/exports to manage supply and prices, e.g., reducing import duties or imposing export bans.
  • Infrastructure Development: Invests in cold storage, warehousing, and transportation to reduce post-harvest losses.
  • Technology Adoption: Promotes precision farming and weather forecasting to boost productivity and lower costs.

Different Indices Measuring Food Inflation in India:

Consumer Price Index (CPI):

  • Tracks retail inflation for goods and services, including food, across different consumer groups.
  • Types: CPI for Industrial Workers (IW), Agricultural Labourer (AL), Rural Labourer (RL), Urban Non-Manual Employees (UNME).

Consumer Food Price Inflation (CFPI):

  • Monitors price changes in essential food items like cereals, vegetables, dairy, and meat.
  • A component of the broader CPI-Combined (CPI-C).

Wholesale Price Index (WPI):

  • Measures wholesale inflation focusing on goods, excluding services.
  • Primary articles (22.62% of WPI) include Food Articles (cereals, vegetables, etc.) and Non-Food Articles (oil seeds, minerals).

What is Monetary Policy?

  • Monetary Policy: A central bank’s toolkit for managing the money supply.
  • Goals: Promotes economic growth and stabilises inflation.
  • Key Strategies: Adjusting interest rates and modifying bank reserve requirements.
  • Objective: Ensures financial stability and influences overall economic conditions.

About the Monetary Policy Committee (MPC):

  • Establishment: Formed under the amended RBI Act, 1934, through the Finance Act, 2016.
  • Function: Tasked with setting the benchmark policy rate (repo rate) to control inflation within target levels.
  • Composition: Six members, including the RBI Governor (Chairperson), RBI Deputy Governor (Monetary Policy), one RBI Board nominee, and three government-nominated external members.
  • Tenure: External members serve for four years.
  • Quorum: Four members, including the Governor or Deputy Governor, must be present.
  • Decision-Making: Majority vote, with the RBI Governor holding a casting vote in case of a tie.
  • Binding Nature: MPC decisions are binding on the RBI.

Problems of Food Inflation:

  • High CPI Inflation: CPI inflation has consistently hovered around 5%, primarily due to spikes in food prices like cereals, pulses, and vegetables.
  • Household Expectations: The strong influence of food inflation on household inflationary expectations poses a challenge, with expectations currently at 8%.
  • Economic Survey Suggestion: The latest Economic Survey proposed excluding food prices from CPI inflation targeting, given their volatility and significant weight in India’s CPI basket.
  • Developed vs. Developing Economies: The higher share of food in India’s CPI basket compared to developed countries makes it challenging to implement an inflation-targeting monetary policy.
  • Monetary Policy Limitations: Monetary policy primarily addresses demand-side factors and is less effective in controlling supply-driven food inflation, complicating CPI targeting.

Holistic Approach to Inflation Targeting:

  • Supply vs. Demand Inflation: The RBI needs to differentiate between supply-induced and demand-side inflation, focusing on assessing the nature of supply-induced inflation.
  • Vegetable Price Volatility: Transitory components like vegetable prices need critical assessment, as CPI inflation excluding vegetables has been below 4% for the last five months.
  • Monsoon Impact: A satisfactory monsoon could lead to moderation in food inflation, but achieving the RBI’s 4% target on a durable basis remains challenging.
  • Inflation Projections: The RBI has retained its average inflation projection at 5% for FY25, while some analysts project a slightly higher rate of 4.8%.
  • GDP Growth Outlook: Despite concerns around consumption demand and private investment, the RBI maintains its GDP growth projection at 7.2% for FY25, supported by healthy high-frequency indicators.

Global Economic Context:

  • Geopolitical Turmoil: The global economy faces increased geopolitical risks, coupled with lingering growth concerns, creating a challenging external environment.
  • Monetary Policy Divergence: Central banks worldwide are adopting divergent monetary policies, with some cutting rates and others increasing them, reflecting varied economic conditions.
  • US Federal Reserve: The US Federal Reserve is expected to start cutting rates from September, indicating a shift in its monetary stance.
  • India’s External Sector: India is relatively well-positioned in the external sector, with a comfortable current account deficit, healthy capital inflows, and high forex reserves.
  • Liquidity Concerns: The RBI has raised concerns about the mismatch between bank deposit growth and credit growth, which poses liquidity risks for the banking sector.

Structural Changes in Consumption and Investment:

  • Credit-Deposit Ratio: The credit-deposit ratio has risen due to higher credit growth and muted deposit growth, influenced by household savings shifting to higher-return asset classes like equity.
  • Personal Loans Growth: The personal loans segment has seen sharp growth, driven by structural changes in household consumption and investment patterns.
  • Digitization’s Role: Digitization in the economy has facilitated changes in consumption and investment behaviour, contributing to the growth in personal loans.
  • Regulatory Tightening: While retail loan growth moderated after the RBI tightened regulatory norms, it continues to grow at a high pace, necessitating caution.
  • Future Outlook: The RBI will continue monitoring inflation trends, with food inflation playing a critical role in shaping future policy decisions, potentially leading to a shallow rate cut if inflation moderates.

The Impact of Food Prices on Economic Indicators

  • Consumption Demand: High food prices can reduce disposable income, leading to weaker consumption demand and slowing economic growth.
  • Rural Economy: Rural areas, where food expenditure forms a larger share of total spending, are particularly vulnerable to food price inflation.
  • Investment Decisions: Persistent food inflation may cause uncertainty, leading businesses to delay or scale back investment plans.
  • Fiscal Pressure: Governments may face fiscal pressure to increase subsidies or other support measures to mitigate the impact of rising food prices on vulnerable populations.
  • Wage-Price Spiral: Rising food prices can lead to higher wage demands as workers seek to maintain their purchasing power, potentially fueling further inflation.

The Role of Supply-Side Interventions:

  • Agricultural Productivity: Enhancing agricultural productivity through technological advancements and better farming practices can help stabilise food prices.
  • Supply Chain Improvements: Strengthening supply chains and reducing bottlenecks can minimise disruptions and ensure a steady supply of food products.
  • Buffer Stocks: Maintaining adequate buffer stocks of essential commodities can help mitigate the impact of short-term supply shocks on food prices.
  • Climate-Resilient Agriculture: Investing in climate-resilient agricultural practices can reduce the vulnerability of food production to adverse weather conditions.
  • Policy Coordination: Coordinated efforts between monetary and fiscal policies, along with targeted interventions, can effectively address the challenges posed by food inflation.

Challenges for RBI’s Monetary Policy:

  • Food Price Volatility: Unpredictable food prices due to climatic factors make inflation management challenging.
  • Limited Control Over Supply-Side Inflation: Monetary policy is less effective in addressing supply-driven food inflation.
  • Inflationary Expectations: Persistent high food inflation can entrench inflationary expectations, complicating policy efforts.
  • Balancing Growth and Inflation: The RBI must navigate the delicate balance between supporting economic growth and controlling inflation.
  • Global Economic Uncertainty: Geopolitical tensions and global economic shifts add external pressure on domestic inflation.
  • Impact on Consumption and Investment: High inflation can dampen consumer spending and delay investment, affecting overall economic momentum.
  • Policy Communication: Managing market expectations and effectively communicating the RBI’s policy stance is increasingly complex in a volatile environment.

Way Forward for RBI’s Monetary Policy:

  • Inflation Monitoring: The RBI must closely monitor food inflation trends to determine the transient and persistent components, guiding future policy actions.
  • Rate Cut Possibility: If food inflation shows signs of moderation and core inflation remains stable, the RBI may consider a shallow rate cut towards the end of the year.
  • Holistic Inflation Targeting: A balanced approach to CPI inflation targeting, considering both supply-induced and demand-side factors, is crucial for effective monetary policy.
  • Global Considerations: The RBI needs to remain cautious of global economic conditions and geopolitical risks, which could impact India’s external sector and monetary policy.
  • Structural Reforms: Continued focus on structural reforms, especially in the banking sector and digitization, will be essential to address liquidity risks and support sustainable economic growth.

Conclusion:

Rising food prices present a complex challenge for the RBI, as they significantly influence inflationary expectations. While monetary policy can address demand-side factors, supply-driven food inflation requires a multifaceted approach, including supply chain improvements and climate-resilient agricultural practices. Achieving stable inflation in this context remains a critical but difficult task.

Source: The Indian Express

Mains Practice Question:

Discuss the challenges faced by the RBI in managing inflation in India, particularly in the context of food price volatility. How can supply-side interventions complement monetary policy to ensure stable inflation? Analyse with examples.”

Associated Article:

https://universalinstitutions.com/caution-no-cuts-ahead/