BackRBI is looking through core inflation, and it may be right this time around
RBI’s own forecasts of headline inflation have been rather benign despite factoring in the sticky and elevated coreSome experts say that monetary policy has to take into account the trade-off between growth and inflation
PremiumHousing, healthcare and education have been the deadly trio that have upset an otherwise benign narrative on India’s inflation. The debate currently is whether the Reserve Bank of India (RBI) is right in responding to the subdued headline inflation rate, even though some of its components are running amok.
As Chart 1 shows, adjusted to their weights in the index, housing, healthcare and education have been among the top 10 contributors to inflation over the last one year. A variety of reasons have been given for this rise, ranging from the government’s healthcare insurance push to a better capture of inflation data by surveyors.
Be that as it may, the data is out there and economists believe the price pressures from healthcare and education would remain. Housing, on the other hand, could peter down, signs of which are already visible (see Chart 2). Housing inflation has been slowing down over the past six months, and the overhang of inventories is likely to nullify the second-round impact of the hiked house rent allowances to government employees two years ago.
Historically, services inflation and most of its components have shown a higher degree of inelasticity or stickiness. Core inflation tends to remain at the level it has risen to, although small episodes of easing have also been noticed.
Economists have pointed out that there aren’t enough schools, hospitals or supporting infrastructure to meet the rising demand for these services. While per capita income has grown, prompting Indians to spend more on services (even discretionary), the supply hasn’t kept pace. In a nutshell, there are structural shades to core inflation.
Abheek Barua, chief economist at HDFC Bank Ltd, believes that for monetary policy, it is imperative to avoid giving a cyclical prescription to structural drivers, and policy rate changes are just that. “I think there are structural factors in play as well and it is prudent to sometimes look through them, as monetary policy tools are cyclical in nature," he said.
To that extent, RBI is perhaps not wrong in looking through the core inflation threat before it has more intelligence on the components. What’s more, RBI’s own forecasts of headline inflation have been rather benign despite factoring in the sticky and elevated core.
Also, some experts say that monetary policy has to take into account the trade-off between growth and inflation. In other words, the price that the economy will pay to keep a lid on inflation should not be so high that it defeats the purpose of inflation targeting. “Ultimately should we allow for some overheating so that the economy can achieve its desired level of growth? That is the question that the RBI has to answer," said Barua.
If overheating is a medium-term issue, like lack of appropriate supply, as is the case with healthcare and education, the central bank should be conscious of this. That means the best course of action may be to sit it out.
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