By Ashok Gulati & Manish K Prasad
RBI has the unenviable task of keeping inflation within a 4±2% range. Lately, despite its best efforts, inflation has remained defiant and above its tolerance band. In June 2022, Consumer Price Index (CPI) inflation was at 7.01%, and Wholesale Price Index (WPI) inflation at 15.18%. For FY23, RBI seems to have admitted that inflation will stay above 6%, and even may settle at 6.7%.
The RBI Monetary Policy Committee (MPC) has already hiked the repo rate—the central bank’s brahmastra—by 90 basis points, raising it to 4.9% in June 2022 to tame inflation. It is likely to rise further to at least 5.5%, if not more, over the course of this financial year. But will this be enough to tame inflation? The short answer is ‘probably not’. The underlying reason is the nature and structure of inflation in India.
The CPI basket in India comprises 299 commodities grouped into six major categories. The food and beverages group has a weight of 45.86% (with food at 39.06%, prepared meals at 5.55% and non-alcoholic beverages at 1.26%). The consumer food price inflation (CFPI) was at 7.75% in June, a bit higher than overall CPI inflation.
It is this overwhelmingly high weight of food in the CPI, based on Consumer Expenditure Survey (CES) data of FY12, that distinguishes Indian inflation from many other developed countries where food weights are much smaller. For example, Germany (8.5%), the UK (9.3%), the US (13.42%), Canada (15.94%), France (16.49%), Australia (16.8%), China (19.9%), Japan (26.3%), and even developing nations such as South Africa (17.24%), Brazil (25.5%), and Pakistan (34.83%), assign lower weightage to food in overall CPI than India. Higher the weight of food in the overall CPI, the more difficult it is for monetary-policy-squeeze alone to contain inflation.
Let us explain this in some detail. The accompanying graphic shows the contribution of each group/item to CPI inflation in June 2022. Food and beverages contributed about 52% to CPI inflation, with CFPI alone contributing 45%. The highest contribution came from vegetables, at 14.6%. Within food, after vegetables, cereals and products clocked 7.2%, meat and fish 5.6%, milk and milk products at 5.6%, and oil and fats 5.5%.
Let us dive a bit deeper into vegetables. Interestingly, of the 299 commodities that comprise CPI, the highest contributor to overall inflation was tomatoes alone at 8.9%. Inflation in tomatoes was astoundingly high at 158.8% (y-o-y). A key reason was the low base effect, as inflation in June 2021 was negative 14.4%. Due to low price realisation last year, tomato-farmers shifted acreage to other crops this year. On top of that, some tomato-growing areas got flooded while many others faced heat waves that further depressed tomato supplies. No wonder it led to a perfect storm in tomato prices. What can RBI’s repo rate hikes do to contain troubles coming from tomatoes?
The real solution to tomato inflation may lie beyond the remit of RBI. It requires linking tomato value chains to processing at least 10% of the production into tomato paste and puree during bumper years and using them when fresh tomato prices spike. Further, to enhance the affordability of processed tomatoes, the GST rate on this needs to be reduced from 12% to 5%. This would help farmers stabilise their incomes and avoid the problems they face in case of perishables.
This time, it is tomato that has caused trouble, and the next time, it could be onions or potatoes humbling RBI on inflation front. RBI, with its mighty repo rates policy, may feel helpless! It is because of this reason that late Arun Jaitley sanctioned a scheme called TOP (Tomatoes, Onions, and Potatoes) and allocated Rs 500 crore to streamline their value chains. Even prime minister Narendra Modi said in one of his speeches that ‘TOP is our top priority’. The scheme was expanded to become TOTAL by including several other vegetables. Without a champion like Verghese Kurien in the case of milk, the focus for this scheme (first, as TOP and then TOTAL) got diffused, and thus the scheme has not had any visible impact on the vegetable value-chains.
Another case illustrates how helpless RBI is in taming food inflation. Cereals and products have the highest weight (9.67%) in the CFPI basket; these had an inflation rate of 5.7% in June 2022. Within this, wheat registered the highest inflation, at 10.1% in June 2022 (y-o-y), due to low availability on account of the marginal drop (less than 5%) in production but a massive fall (more than 50%) in procurement (y-o-y). The government abruptly banned wheat exports on May 13, sensing trouble due to the heat wave impact as well as export demand that pulled domestic wheat prices above the minimum support prices (MSP). What could RBI do in such a situation? Its monetary policy may not help contain wheat prices.
There are several other examples of food items, such as milk and products, and meat and fish, which together contributed more than 10% to CPI inflation in June, that show RBI’s policy actions may not help. Edible-oil inflation is strongly impacted by global prices of palm, soya and sunflower oils, and what Indonesia does with its export policy with regard to palm oil, etc.
The upshot of all this is that the nature and structure of inflation in India is very different from that of developed countries. So, monetary policy alone may not be as effective in the Indian case. India desperately needs to revise its CPI with the latest consumption-survey weights. And our parliamentarians must recognise the limitations of RBI in taming inflation. Tremors in tomato prices alone can humble the mighty RBI!
The writers are, respectively, Infosys Chair professor for agriculture, and research assistant, ICRIER.