By officially committing to inflation targeting through the signing of a monetary policy agreement between the finance ministry and the RBI, India has joined 28 other countries in explicitly fixing goals for annual increases in the consumer price index (CPI) and pinning responsibility on the central bank for achieving them.
Interestingly, among the now 29 countries, India has the lowest per capita income. While there are as many as 13 in the list with nominal per capita incomes below $10,000 a year, India’s, at $1,509 (IMF data for 2013), is lower than even that of the Philippines ($2,790) and Ghana ($1,871). But that isn’t the sole factor that makes India’s adoption of inflation targeting, underpinned by a formal legal framework, rather unique.
Unlike in other countries, India’s CPI has very high weightage for food and non-alcoholic beverages (FNB) — 45.86 per cent in the new 2012-base combined index. The FNB contribution to the CPI is lower even for Ghana (43.48), the Philippines (38.98), Thailand (33.48), Brazil (24.6) and South Africa (17.5), not to speak of New Zealand (18.84), Canada (16.4) or the UK (11.2).
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The monetary policy framework, signed on February 20 and made public on Monday, obliges the RBI to contain CPI inflation under 6 per cent by January 2016, while fixing it at 4 per cent (subject to a plus/ minus 2 per cent band) for 2016-17 “and all subsequent years”.
While 6 per cent or less seems quite feasible for the moment, the question to ask is how the targets are going to be met on a sustained basis. CPI inflation averaged 10.19 per cent in 2012-13 and 9.49 per cent in 2013-14. Food inflation averaged higher, at over 12 per cent, during these two years. Since October, though, overall CPI inflation has fallen to an average of 5 per cent. Average CPI food inflation has been even lower, at 4.9 per cent, during the four months ended January.
It follows from this that CPI inflation is significantly tied to food inflation. Given the latter’s high weightage in the CPI, the success of inflation targeting in India is predicated on what happens to food prices. The general declining trend in inflation from July, accelerating since October, has had mainly to do with food and fuel. In both cases, external factors — sliding global oil and farm commodity prices — and not the RBI’s monetary policy have been crucial.
Monetary tightening has, no doubt, worked in controlling “core” manufacturing inflation — although, in the process, it has inflicted collateral damage in the form of a longer than necessary slowdown. We are now beginning to see some loosening of policy, thanks to receding inflationary pressures, in which high repo rates have, however, played a minimal part.
Now, we don’t know when these external factors may turn unfavourable — be it on account of geopolitics or extreme weather events — and push up CPI inflation all over again, simply by virtue of food’s large share in the index.
Does it make sense at all, then, to target inflation — that too at the retail end — while blaming the RBI for overshooting? The framework agreement, in fact, requires the RBI to give “reasons for its failure” to meet the targets and also propose “remedial actions”. Such actions will obviously mean hiking repo rates, even when we know these would make no difference to onion or tomato prices.
While inflation targeting has some rationale in advanced economies, where food’s contribution to the CPI and consumption expenditures is barely 20 per cent, and agricultural markets are far more organised, there is an inherent danger of it creating an anti-farmer policy bias in a country like India. Can one make rational projections of food inflation here? Considering the sheer unpredictability of such an exercise, wouldn’t the rigid commitment to CPI inflation targets naturally predispose policymakers towards freezing minimum support prices, imposing restrictions on farm exports on the slightest pretext and opening up to duty-free imports with or without the WTO?
Any policy that ultimately affects the incomes and livelihoods of large sections of the population should be debated and approved by Parliament first. It is fair to believe that targeting CPI inflation has the potential to impact the country’s 300 million-plus farming population. One wouldn’t debate the issue much if the RBI were to target only “core” CPI inflation that strips out the volatile food and fuel components.
There are, of course, many who would see a discussion on the country’s monetary policy framework by elected people’s representatives as gravely threatening the central bank’s autonomy. They should be reminded that it is the same Parliament that passed the Fiscal Responsibility and Budget Management Act to institutionalise governmental financial discipline during the tenure of the last NDA regime. Subsequently, most state assemblies followed suit in enacting their own versions of the same legislation.
Let’s trust our politicians to make similar informed judgements on inflation targeting.