Headline inflation should continue to be the target, says BS poll

Economists back headline CPI as India's inflation target, stressing food's heavy weight in consumption and urging RBI to retain the 4% benchmark with the current tolerance band

The retail-inflation rate should stay as the monetary-policy benchmark, according to all the participants in a Business Standard poll of 10 economists, as India continues to be a middle-income country and the share of food will be substantial even in the new basket of consumer price inflation (CPI). 

Last week, the Reserve Bank of India (RBI) floated a discussion paper ahead of the second review of the inflation-targeting framework (FIT), due by the end of March 2026. 

The economic survey for FY24 suggested a reexamination of the inflation targeting framework  and said the framework should target inflation excluding food.  The survey said when food prices rise, inflation targets come under threat, which prompts the central bank to appeal to the government for bringing down the increase in the prices of food products. This, in turn, prevents farmers from benefiting from the rise in terms of trade in their favour. 

“The headline inflation rate (CPI) in our view should be [the target] because India is still a lower middle-income economy. Even in the new CPI basket, the percentage spent on food will still remain closer to 40 per cent. And that is substantial,” said Anubhuti Sahay, head, India, (economics research), Standard Chartered Bank. 

“The core inflation rate (non-food, non-oil), to that extent, will not be able to capture the impact on the economy per se,” she said.

After the flexible inflation-target regime was introduced in October 2016, the average inflation rate hovered around the target, 4 per cent, from 2016-19. 

 

With the outbreak of the pandemic and the associated supply-chain disruption, the rate breached the upper-tolerance band in a few quarters during 2020-21 and 2021-22. 

Following the Russia-Ukraine conflict, it again strayed from its target and peaked at 7.8 per cent in April 2022.

On the whole, according to the discussion paper, the inflation rate over the nine years of the framework shows a hump-shaped performance with the first three years and last three years remaining aligned to the target. 

The middle three years showed an incline towards the upper tolerance band confronted with a once-in-a-century pandemic followed by the Russia-Ukraine conflict, which drove up the inflation trend worldwide during this period. 

Cross-country experience suggests that almost all countries targeting inflation have chosen the CPI as the reference point, irr­esp­ective of their level of tar­get and stage of development. Uganda is the only country that targets the core-inflation rate.

On the question on whether the 4 per cent target should continue to remain optimal, nine of the 10 respondents said “yes”, while Bank of Baroda said the target should be at least 5 per cent. 

“The 4 per cent headline inflation rate should continue to remain the target for monetary policy, which is in line with productivity differentials with developed countries,” said Gaura Sen Gupta, chief economist, IDFC Bank.

 

On whether the tolerance band could be narrowed or widened, Bank of Baroda said it should be narrowed while ICICI Securities Primary Dealership said the lower band (2 per cent) could be increased. All other respondents said the band, with a 2 per cent elbow-room on either side, should be retained. 

On whether the target should be removed and only a range be maintained, all respondents said the RBI should continue to have a target.

The RBI has invited comments on the discussion paper by September 18.

 

“A point target provides clarity in communication, which keeps inflation expectations in check. A range would signal a dilution of focus on inflation,” Sen Gupta said.