It's Mostly Food: How to Tame Indian Inflation

IMF Blog, March 10, 2016

Source details

Authors: Rahul Anand, Paul Cashin
Publication date: March 10, 2016
Topic: Analysis of inflation in India with emphasis on food inflation and implications for monetary policy under India’s flexible inflation targeting framework.
Historical trajectory cited:
- Inflation trended higher from the mid-2000s.
- It reached 10–11 percent by 2008.
- Inflation fell by almost half in 2014, but inflation expectations remained high.
Quotation: Reserve Bank of India Governor Raghuram Rajan: “inflation is a destructive disease … we can’t push inflation under the carpet as a central banker. We have to deal with it.”

Food inflation in emerging markets (including India) is more volatile and persistent than in advanced economies.
Food inflation developments in India over the past decade largely reflect demand pressures driven by strong private consumption growth, which have often outpaced supply of key food commodities.
Inflation has costs:
- It hurts growth.
- It worsens inequality.
- There is an inflation-growth threshold effect in the Indian states with persistently elevated consumer price index inflation rates of over 5½ percent.
- Higher non-food inflation is associated with worsening income inequality in both urban and rural areas.
Inflation dynamics in Nepal and Bhutan are closely linked to those in India.

Food inflation developments matter because:
- The share of food expenditure is high in total household expenditure.
- Food inflation informs inflation expectations and wages.
- Second-round effects of food inflation are large in India, implying monetary policy must respond to large and persistent food price shocks.
Policy stance on inflation targeting:
- Analysis suggests responding to headline inflation rather than core inflation is welfare superior and often better to mitigate consumption and output fluctuations.
- Sustaining the long-term inflation target of 4 percent under India’s recently adopted flexible inflation targeting framework depends on:
- Enhancing food supply,
- Agricultural market-based pricing,
- Reducing price distortions.
- In the absence of a stronger food supply growth response, food inflation may exceed nonfood inflation by 2½–3 percentage points per year.
Reserve Bank of India guidance:
- Given high costs of inflation, the Reserve Bank of India needs to balance the short-term growth-inflation trade-off, in light of the long-term negative effects on growth of persistently high inflation.

Chapter 4 highlights:
- Use of micro level data (household survey data) to investigate demand and supply factors underpinning relative food price inflation.
- Analysis of non-monetary factors responsible for relative food price inflation.
- Policy advice aimed at achieving inflation targets under India’s flexible inflation targeting framework.

Source: It's Mostly Food: How to Tame Indian Inflation, Rahul Anand and Paul Cashin, March 10, 2016.