Delving into the contentious issue of whether monetary policy should look through rise in headline inflation due to spikes in food prices, which are caused by events that cannot be controlled by interest rate changes, a research paper by Reserve Bank of India (RBI) deputy governor Michael Patra, along with Joice John and Asish Thomas George, concluded that there are times when food inflation mimics core inflation.
“With its large share in the consumption basket, food inflation has the potential to affect headline inflation. And, it can also affect non-food inflation in the event of large and repeated food price shocks,” the paper said.
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While the authors are from the RBI, the views do not represent that of the central bank.
The report observed that in the wake of the pandemic –exacerbated by the war in Ukraine – the intersecting incidence of food price spikes has had an overbearing influence on headline inflation in India.
Widely regarded as transient, these shocks appear to have imparted volatility and persistence to food inflation which averaged 6.7 per cent during April 2022 to November 2023, it said.
Food has a weight of 45.9 per cent in the consumer price index (CPI). But its contribution to overall inflation has increased from 48 per cent in April 2022 to 67 per cent in November 2023.
The report titled ‘Are Food Prices the True Core of India’s Inflation?’ highlighted two factors.
They are the rising vulnerability of food prices to climate change. El Nino, for example, suggests that food inflation in India may be acquiring a structural character.
Second is the weaponisation of food as a consequence of geopolitical conflict and restrictive trade practices embedded in geo-economic fragmentation. This is resulting in large spillovers, propagating into non-food inflation across geographies.
“These forces are causing headline inflation in India to diverge, often persistently, from its target of 4 per cent,” the report said.
The findings of the food inflation dynamics showed that on an average, food inflation has ruled close to headline inflation.
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The report said when food inflation shocks have been large and persistent they have spilled over to prices in the non-food categories. But in the long-run, food inflation tends to converge to non-food inflation.
The report said ascertaining the sources and nature of these shocks is clearly the remit of risk-minimising monetary policy. This is because its goal of price stability can easily be undermined by the de-anchoring of inflation expectations and the broadening of inflation pressures due to food price shocks
“At the same time, wielders of monetary policy need to be conscious of the dangers of overkill in reactions to a transitory food price shock and also of the pitfalls of benign neglect of looking through persistent food price shocks,” the report concluded.