CPI key to monetary policy; tweak food basket as per housing spend trends: Economists

Ever since inflation yet again reared its ugly head, pushing back the much-awaited monetary easing by the Reserve Bank of India (RBI), the central government, from various quarters, started questioning use of overall retail inflation, which includes food inflation, as one of the determining factors for policy rate decisions.

First, Commerce and Industry Minister Piyush Goyal said basing the rate decision on food prices, which are inherently volatile due to seasonality, is a “flawed theory”. Later Chief Economic Advisor V Anantha Nageswaran said retail inflation is driven by a few commodities like tomato, onion, and potato and dropping them would lower the headline inflation rate to about 4%.

“We know that CPI (consumer price index-based) inflation is being very much influenced by a few commodities. If you take out tomato, onion, potato (TOP), gold and silver, the headline CPI rate is 4.2 per cent,” Nageswaran said at the SBI’s banking and economics conclave earlier this week.

Economist Sunil Sinha, professor at the Institute for Development and Communication, says the issue has been debated at length earlier too. “But a consumer price index has to include the goods, commodities, and services, which are normally consumed by the end users on a daily basis. Otherwise, it will not serve as an appropriate gauge of impact of high prices on the consumers. Globally these items are part and parcel of the index,” said Sinha.   

Sinha argues that not looking at the overall retail inflation as a policy variable is a narrow view. “Those approaching this way are looking only at the first stage impact. High food inflation affecting the household budget will further skew wages and salaries. Even though the inflation spike is due to the food prices, resultant wage demand will have a ripple impact on the economic scheme of things. So, food inflation may not have impacted the core side in the first round but will certainly have a ripple impact later. RBI takes a holistic view of these repercussions and decides the policy in a forward-looking manner,” Sinha adds.

Taking the point further, Rumki Majumdar, economist, at Deloitte India said high food inflation impacts core inflation with a lag. “The RBI focuses on the overall CPI rate, instead of the core CPI, for policy making because persistent high food prices do influence the core prices with a lag. Higher food prices for a long, as we have seen in India, have a second-order impact on wages and prices of other goods such as FMCG products. Currently, even core prices are also rising, although remain below RBI’s target rates,” Majumdar added.

The impact is already showing. “Core inflation rose 3.7% in October 2024, highest in ten months, led by higher inflation in housing, education and personal care and effects categories,” Motilal Oswal Financial Services said in its Ecoscope report.

The way out

The economists suggest that the government needs to revise the weight of the food basket which currently stands at 45.86 in line with the latest Household Consumption Expenditure Survey 2023 -24.

“One of the ways to address it is to have a higher target rate than 4%, which is what the economic survey suggested during the budget. Besides, a revision of the weight allocated to food in the CPI index is critical. The recent HCES 2023-24 suggests that the proportion of spending on food in total household spending has declined, both in urban and rural areas. So, the weightage given to food in the overall CPI index should commensurately come down. The government is working towards revising the CPI and we will likely see a better CPI estimate soon, giving the right guidance to the RBI,” Majumdar added.

“Over the years, the weight of the food items has reduced in the CPI index. In the current base, the weight is lower than the base year of the early 90s or 2005. So, it is not static. It is dynamic based on the household consumption expenditure. India is a developing economy, significant amount of expenditure by many households is oriented towards food. So, weight must be given accordingly,” Sinha said.