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Inflation management in India has been in the news due to rising prices of essential goods and commodities. With the failure of RBI and govt to control the spiralling inflation in the economy, economists have pointed to explore alternative ways of Inflation Management in the country.
What is the present level of Inflation in the Economy?
Current Inflation in the economy Consumer Price Index (CPI) estimates show that CPI Inflation moderated to 6.8% in August from 7.4% in July. Food inflation is still high even though it has come down from a high of 11.5% in July to 9.94% in August. The dip is primarily a result of moderation in vegetable price inflation. However,two major food categories, cereals and pulses, continue to show double-digit inflation.
This present level of inflation is higher than the upper limit of the Inflation(6%) which has been set by the Govt.
Read More- Inflation in wheat and rice
What is Inflation?
Inflation- Inflation refers to the rise in the prices of most goods and services of daily or common use such as food, clothing, housing, recreation, transport, consumer goods. Inflation measures the average price change in a basket of commodities and services over a period of time.
Types of Inflation
| Demand Side inflation | Demand Side Inflation is caused by high demand and low production which creates a demand-supply gap and it leads to a hike in prices due to increase in consumption. |
| Cost Pull inflation | Cost Pull Inflation is caused by shortage of factors of production like labour, land, capital etc. and also due to artificial scarcity created due to hoarding. |
Inflation Target in India
The Reserve Bank of India is the authority to control inflation under RBI Act 1934.
| Inflation Targeting Regime of RBI | |
| Began in 2016. Central govt fixes the target for RBI’s Monetary Policy Committee for 5 years. | RBI has to retain the inflation target of 4%, with a tolerance band of +/- 2 percentage till March 2026. |
Read More- RBI Monetary Policy Committee
How is Inflation Management done in India?
Inflation management is a complex task as inflation is caused by several factors such as demand-pull factors, cost push factors and structural factors. Therefore a mix of macro-economic policies are needed to manage the inflation in the economy.
| Main Tools For Inflation Management | |
| Monetary Policy | Monetary Policy tool is employed by the RBI to control the supply of money in the economy. RBI applies the repo rate to control the supply of money in the economy. By increasing the repo rate RBI tries to bring down the rate of inflation in the economy. |
| Fiscal Policy | Monetary Policy tool is employed by the Govt manage inflation through public expenditure and taxation. Government tries to reduce inflation by raising the tax rates and reducing public expenditure. |
| Other tools for Inflation Management | |
| Export policy | The government can temporarily ban the export and imposes Minimum Export Price (MIP) to discourage exports of certain commodities to ensure their availability in the domestic markets.Ex-Recent rice export and onion export ban. |
| Price control Policy | Under the Essential Commodity Act 1955, the government can declare a commodity as an essential commodity to ensure supplies to people at fair prices. |
| Anti-Hoarding and Anti-speculation Policy | The Prevention of Black Marketing and Maintenance of Supplies of Essential Commodities Act, 1980 allows for detention of persons engaged in activities like hoarding, creating artificial scarcities of essential commodities in the market and rigging up of the prices. |
What are the present challenges with Inflation Management in India?
Rising Food Inflation- India’s food and oil components of the consumer price index CPI are about 50%. The RBI has no control over the prices of food and oil. Therefore, it is left to squeeze less than 50% of the domestic economy to lower inflation.This is the biggest challenge for inflation management in India. For Example- Current CPI in India has been fuelled by the rising food and vegetable prices over which RBI’s monetary policy is ineffective.
Failure in addressing supply shocks- Government has adopted a myopic vision in inflation management by focussing on export ban of agricultural products(like wheat,rice,onions). Export bans induced fear and panic in the domestic market, led to rise in stock holdings which ultimately resulted in price rise. Instead government should have focused on addressing the supply shocks of agricultural products like raising minimum procurement prices for cereals, onions and supply of these items through PDS system.
Monetary Policy singular focus on demand side- RBI’s monetary policy targets only demand constraints. It faces the problem of tackling Supply shocks originating from food and oil. If output is stabilised using macroeconomic policies, it can further lead to prices rise.
Flawed Model of Inflation targeting- Monetary Policy model used for Inflation management in India is not statistically validated for Indian data. The current model of Inflation targeting is based on the assumption that inflation means overheating the economy-that is increased output greater than natural level output. However, In India it is impossible to observe the actual level of output in an economy. Hence, setting policy rates based on the assumption that the economy has overheated is unscientific.
Exclusive Focus on Inflation slows down growth- RBI’s current mandate of inflation management is too singularly focused on controlling inflation. Inflation management has negatively impacted GDP growth. High policy rates (repo) maintained to control inflation affected the cost of domestic capital. It led to a decline in investment rate thereby resulted in less GDP. For example, since 2016, (after inflation rate targeting was institutionalised), there has been a steady increase in repo rates, and a steady decline in GDP growth.
Adverse impact on other sectors- The cases of IL&FS, PMC Bank, PNB and YES Bank suggest that poor management and maladministration in the financial sector can escape RBI scrutiny as they tend to focus more on inflation management.
Global Nature of inflation- Inflation is global in nature as the price level of a good is determined by millions of producers across the world. Hence solely targeting inflation management is not good for the health of the economy as certain prices of goods are beyond our control.
What should be the way forward for inflation management in India?
Inflation management to shift from headline to core-inflation– RBI’s mandate should be on managing the core inflation (exclusion of fuel and food) rather than headline inflation.There must be incorporation of other growth indicators such as nominal GDP explicitly into the framework.
Updation of the CPI Basket Weights- The weight of food and beverages in the CPI basket should be adjusted to reflect current realities as the weights are based on the 2011 consumption survey.
Aligning the shut down period with global practices- Shut down period is the period, in which MPC members maintain complete silence, i.e. no media coverage. It is observed before a few days of a policy decision and till few days after the decision. It ensures no sudden volatility in the market and effective market transmission. At present the shut period is seven-day after the release of the monetary policy committee (MPC) resolution. The RBI wants to reduce this to 3 days after the resolution in line with the global practices. The RBI predicts that this will provide better monetary policy transmission(in RBI’s Currency and Finance report)
Expansion in the ambit of Monetary Policy Committee(MPC)- The inclusion of liquidity issues like liquidity adjustment facility, changes in reverse repo, and OMOs in the MPC discussion may result in greater transparency and effective procedures.
Greater Tolerance of Higher levels of Inflation- Since Inflation is a global issue there must be greater tolerance for higher levels of inflation either by adjusting the acceptable range of inflation upwards, or by extending the period over which the MPC has to meet its inflation target.
Release Excess Buffer Stocks- The government holds more than 40 million tonnes of rice, much above the buffer stock norms of 13.5 MT. This excess stock should be unloaded by Food Corporation of India in the open market at reasonable prices. This will cool down the food inflation.
Enhancement of Processing Capacity- About 10-15 percent of perishable items like tomatoes and onions should be processed. The availability of alternatives like tomato paste and onion powder will help to stabilize prices.
Adjustment of Import Duties- Import duties on items like wheat should be reduced as cheaper imports can help control domestic prices.
Read More- Inflation Management Livemint
