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Photo: Abhijit Bhatlekar/Mint
Photo: Abhijit Bhatlekar/Mint

Opinion | The Reserve Bank’s inflation headache

The central bank’s 6% upper limit was breached last month. This may be a blip, but if food prices continue to rise, it may have to give up either its inflation aim or easy-money policy

Retail inflation ripped its way above the central bank’s 6% ceiling in December, with the headline number for that month rising to 7.35%. Food inflation, which roared to 14.12%, is chiefly to blame. Almost all sub-categories in the official food basket—which constitutes 45% of the consumer price index—recorded upturns in price levels. Vegetables, the most volatile of the lot, saw prices soar 60%. This is what the Reserve Bank of India (RBI) had feared when it paused its interest rate easing cycle last month and warned of rising inflationary expectations, though it is not clear if it had anticipated such a sharp increase. In the statement it issued, it had raised its inflation projection for the second half of 2019-20 to 4.7%-5.1%, but also said it expected food prices to ease and pull retail inflation back into its comfort zone of 3.8%-4% in the first six months of 2020-21. It could well turn out that inflationary pressures are quickly contained, but for now, RBI needs to worry about adhering to its government-set mandate of keeping inflation in a band of 2% to 6% under a five-year commitment made in 2016. Whether this can be done without sucking money out of the economy is the big question.

The surge in food inflation is largely due to uneven monsoon rains that left much of the summer crop damaged last year. The winter crop is progressing on schedule, though, and is expected to be better, thanks to extended precipitation over the season having recharged groundwater levels. Vegetable crop cycles are short, and the signals that farmers get from price spikes tend to elicit a supply response in a matter of weeks. The government also has the option of imports. All this would suggest that prices may see moderation ahead. If so, then December’s figure could be treated like a blip. Many monetary policy wonks have made a case for overlooking food price volatility, arguing that RBI need not react to any and every sign of such trouble, unless there are signs of a persistent uptrend. Yet, its own caution in lowering its policy rate further would indicate that it is wary of complacency on this front. Another risk that has not receded as much as RBI would perhaps have liked is of oil prices, which jumped on account of hostilities in West Asia.

What compounds calculations is the fact that Indian industry is yet to regain its pricing power, as reflected in subdued core inflation, which excludes food and fuel prices. Demand for manufactured items still looks sluggish, and RBI is aware that tighter credit would worsen conditions not just for businesses, but across the economy. In other words, if food prices do not give up their ascent on their own, the central bank could face a Hobson’s choice. It may have to give up either its inflation target or monetary stimulus. With the Union budget due on 1 February, the central bank would like to look at the government’s borrowing plan for 2020-21 before taking a call on its broad approach to inflation management. But if the proposed fiscal deficit is too large, RBI will have one more risk factor to ponder. Calls may arise to revise its inflation target upwards, but India would be better served over the long term if RBI keeps the rupee’s internal value stable to the extent possible.

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