Introduction
- The Economic Survey 2023-24 has proposed significant changes to India’s approach to inflation management.
- It recommends removing food prices from the inflation target and shifting the focus from ‘headline’ to ‘core’ inflation.
- This shift has raised concerns about whether excluding food items will achieve the desired outcomes.
Inflation
- Inflation refers to the sustained increase in the general price level of goods and services in an economy over a period of time.
- It is commonly measured by the percentage change in a price index, which tracks the prices of a basket of goods and services that households commonly use, such as food, housing, and transportation.
- For example, if the inflation rate is 5%, it means that on average, prices have increased by 5% over a certain period, typically a year.
Measures Employed in India to Control Inflation
- Inflation management in India is a complex task due to the influence of various factors such as demand-pull forces, cost-push factors, and structural challenges. To effectively manage inflation, a combination of macroeconomic policies is employed. Below are the main tools and additional measures used in India to control inflation:
Main Tools for Inflation Management
Monetary Policy:
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- The Reserve Bank of India (RBI) uses monetary policy to regulate the supply of money in the economy. One of the key tools in this policy is the repo rate, which is adjusted to influence inflation.
- By increasing the repo rate, the RBI aims to reduce the money supply, thereby curbing inflation.
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Fiscal Policy:
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- The government utilizes fiscal policy to manage inflation through public expenditure and taxation.
- By reducing public spending and increasing taxes, the government attempts to lower inflationary pressures in the economy.
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Other Tools for Inflation Management
Export Policy:
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- The government may impose restrictions on the export of certain commodities to ensure their availability in the domestic market.
- This includes measures like imposing a Minimum Export Price (MEP) or outright bans on exports. For example, recent policies included a ban on rice and onion exports to stabilize domestic prices.
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Price Control Policy:
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- Under the Essential Commodities Act of 1955, the government can declare specific goods as essential commodities.
- This allows for the regulation of prices and ensures that essential items are available to consumers at fair rates.
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Anti-Hoarding and Anti-Speculation Policy:
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- The Prevention of Black Marketing and Maintenance of Supplies of Essential Commodities Act, 1980, empowers the government to detain individuals involved in hoarding or creating artificial scarcities.
- This act is used to prevent speculative activities that drive up prices and create shortages in the market.
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Inflation Indices in India
- Wholesale Price Index (WPI): WPI measures the average change in the prices of goods at the wholesale level. The major components include Manufactured Products (64.23%), Primary Articles (22.62%), and Fuel and Power (13.15%). It is significant for determining the GDP deflator and is a critical indicator of economic trends.
- Consumer Price Index (CPI): CPI reflects the change in prices of goods and services that households purchase for consumption. The key components include Food and Beverages (45.86%), Housing (10.07%), Transport and Communication (8.59%), and Fuel and Light (6.84%). CPI is the primary index used by the Reserve Bank of India (RBI) for its inflation-targeting framework.
Headline vs. Core Inflation:
- Headline Inflation: This includes all items in the CPI, including volatile components like food and fuel prices. It represents the total inflation in an economy and is often used for public policy and monetary decisions.
- Core Inflation: This excludes food and fuel prices to remove short-term volatility and provides a clearer picture of the long-term inflation trend. Core inflation is often preferred for setting monetary policy as it reflects underlying inflationary pressures.
Inflation Targeting in India
- Inflation Targeting Framework: The RBI, under the Inflation Targeting regime initiated in 2016, aims to maintain headline CPI inflation at 4%, with a tolerance band of +/- 2%. This target is set by the central government and reviewed every five years.
Rationale and Challenges
- Economic Survey’s Recommendation: The Economic Survey has suggested shifting focus from headline to core inflation, arguing that food price fluctuations are transitory and should not dictate long-term monetary policy. However, in India, food inflation has been persistent, suggesting structural issues rather than temporary fluctuations.
- Interdependence of Inflation Components: Food prices significantly influence wages, which in turn affect core inflation. Ignoring food inflation could undermine efforts to control overall inflation.
- Impact on Standard of Living: Given that food constitutes nearly 50% of household expenditure, excluding it from inflation targeting could neglect the economic reality of a large segment of the population, potentially leading to policies that do not adequately address the cost of living.
- Effectiveness of Interest Rates: Higher interest rates intended to control inflation might not be effective in reducing core inflation and could instead increase production costs, further driving inflation.
Challenges in Inflation Management in India
- Focus on Demand-Side Management: RBI’s monetary policy primarily addresses demand-side factors but often fails to tackle supply-side shocks, such as those arising from food and oil prices, which can lead to inflation.
- Statistical Model Limitations: The inflation targeting model assumes that inflation is due to economic overheating. However, this model is not fully validated for Indian data, where the actual level of output is difficult to observe.
- Supply Shocks: Policies like export bans on agricultural products can exacerbate inflation by causing panic and hoarding in the domestic market, leading to higher prices.
- Impact on Growth: The singular focus on inflation control through high interest rates can slow economic growth by reducing investment and increasing the cost of capital.
- Global Nature of Inflation: Since inflation is influenced by global factors, solely targeting domestic inflation may not be effective. External price pressures need to be considered in policy decisions.
Way Forward
- Enhancing Agricultural Productivity: Increasing agricultural production can help stabilize food prices and reduce inflationary pressures. Investments in technology, irrigation, and crop diversification are key.
- Releasing Excess Buffer Stocks: The government could release surplus stocks of essential commodities like rice to stabilize prices in the domestic market.
- Processing Perishable Items: Developing the capacity to process perishable goods, such as converting tomatoes into paste or onions into powder, can help mitigate the impact of seasonal price fluctuations.
- Adjusting Import Duties: Reducing import duties on essential commodities can help control domestic prices, especially during periods of high inflation.
- Updating CPI Basket Weights: Revising the weight of food and beverages in the CPI basket to reflect current consumption patterns can make the inflation measurement more accurate.
- Greater Tolerance for Inflation: Considering the global nature of inflation, India may need to allow for higher levels of inflation within a revised acceptable range, or extend the timeframe for the RBI to achieve its inflation target.