The drop in annual wholesale inflation to an all-time low of minus 2.06 per cent in February, even as food prices are showing a renewed hardening on account of crop damage from untimely rains, highlights a major policy dilemma. On one hand, there is a clear disinflationary trend in the economy, if one were to exclude food and fuel, whose prices are subject to short-term volatility and do not reflect the real underlying inflationary momentum in the economy. By this measure, “core” wholesale inflation was just 0.1 per cent in February and moderate at 4.1 per cent based on the consumer price index (CPI). But on the other hand, wholesale food inflation for the same month was 7.7 per cent and CPI inflation was 7.9 per cent. Food prices could surge further as the supply disruptions from the current weather aberrations play out. This is especially so in crops such as pulses and vegetables, which aren’t widely traded internationally and, hence, relatively immune to the general global commodity bear cycle.
There is a fundamental quandary that the above trend poses to policymakers, more so the RBI. Till even a few weeks ago, it was virtually taken for granted that the coming months would witness a continued loosening of monetary policy. This was seen as necessary, keeping in view the overall sluggishness in growth as well as the ultra-low interest rates prevailing globally. That inevitability of the RBI slashing the repo rate further is now in question, following the damage to the rabi crop from rains, strong winds and hailstorms. It does not help that food constitutes nearly 46 per cent of the CPI. With prices of onions, tomatoes, lentils and other pulses already spiralling, questions are being raised on keeping CPI inflation below even the immediate target of 6 per cent.
But a more pertinent question to ask is whether it makes sense at all to target inflation when a large component is neither amenable to economic forecasting — can anyone predict how the next monsoon is going to be — nor control through conventional monetary policy tools. At the current rate, we could well have negative manufacturing inflation co-existing with double-digit food inflation and interest rates remaining high despite making little difference to the latter. The RBI should probably think in terms of targeting “core” CPI inflation. At 4.1 per cent now, it is well within the target range.