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Editorial of the Day: Weather-Proofing Food Security (Indian Express)

Context: The article is discussing the current state of inflation and economic growth in India, as well as the role of the Reserve Bank of India (RBI) and the Government of India (GoI) in managing these factors. It notes that the recent decrease in the consumer price index (CPI) inflation and food price inflation is a positive development, and that the RBI is hopeful that GDP growth will remain strong. The article emphasises the importance of managing food and beverage prices, which make up the largest component of the Indian CPI, in order to keep inflation under control. Also, it suggests that achieving low inflation and high GDP growth would be a significant accomplishment for the government. More importantly, it notes that managing food and beverage prices is not solely within the realm of monetary or fiscal policy, as external factors such as droughts and supply chain disruptions can have a significant impact on food prices.

Weather-Proofing Food Security Background

  • Inflation: Inflation is defined as increase in prices of goods and services over a period of time. Inflation reduces the purchasing power of currency.
  • Related Terms:
    • Deflation: Decline in inflation rate is called deflation. It is also called negative inflation.
    • Recession: Decline in economic activity (negative growth) in a given period of time is termed recession.
    • Technical recession: An economy enters into a technical recession if there have been two consecutive quarters of negative growth.
    • Stagflation: It is an economic condition marked by low GDP growth, high unemployment rate and high inflation.

Types of Inflation:

  • Cost-push inflation: Cost-push inflation is fuelled by increases in the cost of producing goods and services, rather than by increase in aggregate demand.
  • Demand-pull inflation: Demand-pull inflation occurs due to rise in aggregate demand, as a result of expansionary policies of the government.
  • Built-in inflation: It occurs when workers demand a raise in wages to help maintain their living costs, as a result of increase in prices of goods and services.
Types of Inflation
Types of Inflation

Reasons for Inflation:

Causes of inflation
Causes of inflation

 Effects of Inflation:

  • Reduces purchasing power of households.
  • Rise in inequality as profits for business owners and entrepreneurs rise while the purchasing power of poor sections decrease.
  • Increase in cost of projects due to increase in cost of raw materials.
  • Depreciation of domestic currency due to lower purchasing power parity.
  • Export loses competitiveness due to increase in cost of raw materials.
  • Increase in inflation rate reduces bond yields.

Measures to Control Inflation:

  • Controlling money supply through monetary policy measures, such as increasing repo rate, CRR, SLR.
  • Increasing taxes so as to reduce disposable income, thereby controlling demand.
  • Banning export of certain commodities, especially food, so as to control prices.
  • Reducing import duties on high-demand imported goods such as vegetable oil and petroleum.
  • Appreciation of domestic currency exchange rate to reduce import cost of essential goods.

Inflation Indices:

Inflation Indices
Inflation Indices

Decoding Editorial

The article talks about the sense of relief within the Reserve Bank of India (RBI) regarding the recent data on consumer price inflation (CPI) and food price inflation.

  • CPI Inflation and Food Price Inflation:
    • The CPI inflation for April 2023 decreased to 4.7%, and food price inflation fell even further to 3.84%.
    • There has been expressed optimism that the overall Gross Domestic Product (GDP) growth for the fiscal year 2023-2024 (FY24) will range between 6% to 6.5%.
    • It would be commendable if the RBI can successfully maintain overall inflation below 5% and ensure GDP growth remains above 6% for the entire year.
    • By working together, the RBI and the GoI can potentially attain the desired outcomes of controlling inflation and stimulating economic growth, which would have positive implications, including potential political gains, in the context of the parliamentary elections.
  • Managing Food and Beverage Inflation:
    • In the Indian CPI, food and beverages account for 45.86% of the index, which is the highest weighting among G20 countries. Therefore, managing this component is crucial for controlling inflation.
    • Addressing inflation related to food and beverages is not solely dependent on monetary policy (decisions made by the central bank regarding interest rates and money supply) or fiscal policy (government’s revenue and expenditure measures).
    • This is because the inflation in this component is often influenced by external factors or shocks, such as droughts and disruptions in supply chains.
      • Example: Covid pandemic and the Russia-Ukraine conflict, which had repercussions on food production, transportation, and availability, leading to inflationary pressures.
    • Therefore, managing food and beverage prices requires a multi-dimensional approach, including addressing external shocks, ensuring stable supply chains, and implementing measures beyond traditional monetary and fiscal policies.
  • Implications of EL Nino on Food Inflation: El Niño weather phenomenon can impact the monsoon season in India and its implications for agriculture and food inflation include:
    • El Niño and potential drought: An El Niño that develops, could lead to below-normal rainfall and even a drought. It notes that historically, all drought years in India since 1947 have been El Niño years, although not all El Niño years result in drought.
    • Tug of war between El Niño and Indian Ocean Dipole: There is often a competition or interaction between El Niño and the Indian Ocean Dipole, which can affect the behaviour of clouds and rainfall patterns.
    • Uncertainty and unseasonal rains: The Indian Meteorological Department (IMD) forecast regarding the monsoon expresses concerns about the unseasonal rains in late April and early May, which may not be favourable for agriculture.
    • Hope for the best, prepare for the worst: Adopting a cautious approach by hoping for positive outcomes regarding the monsoon but also preparing for potential challenges is essential.
    • Keeping food inflation below 4%: India must adopt strategies to maintain food inflation at or below 4% in case the monsoon rainfall turns out to be below normal. This implies the need to address potential agricultural challenges and supply disruptions to control food prices.
  • Worrisome Inflation Rates of Important Crops:
    • Rice and wheat inflation: Rice is the major crop during the kharif season (monsoon season), and the non-Public Distribution System (PDS) inflation rate for rice in April was 11.4%. Similarly, wheat, which is a crucial crop during the rabi season (winter season), had a high inflation rate of 15.5%.
    • Uncomfortable level of cereal and products inflation: The overall inflation rate for cereals and cereal-based products is currently at a significantly high and uncomfortable level of 13.7%.
  • Steps to address Cereal Inflation: 
    • Protection through PM-Garib Kalyan Yojana: More than 800 million people in India are receiving free rice and/or wheat (5kg/person/month) under the PM-Garib Kalyan Yojana. This provides protection for these individuals against cereal inflation.
    • Rice stocks and open market operations: Food Corporation of India (FCI) has rice stocks that are more than three times the buffer stock norms. Therefore, the government can intervene by unloading 5 million tonnes of rice from the Central Pool through open market operations. This action could help reduce rice inflation to around 4% and can be done before the rice harvest season begins, typically around September-October.
    • Wheat procurement and open market operations: It is noted that wheat procurement has been sufficient (touching 26MT) to meet the requirements of the public distribution system (PDS) and create room for open market operations. This indicates that the government has enough wheat stocks to manage inflation.
    • Proactive use of buffer stocking policy: Utilizing the buffer stocking policy more proactively is crucial to control cereal inflation. Such proactive measures would be more effective in managing inflation than relying solely on monetary policy instruments.
  • Inflation of Milk Products:
    • In April, inflation of Milk and milk products was at 8.85%. Since it holds the highest weight among the 299 commodities in the Consumer Price Index (CPI) basket, its contribution to overall CPI inflation in April was almost 12%, the highest among all commodities.
    • Reasons for Milk Inflation: There are two factors identified to be contributing to the inflation in milk prices.
      • Firstly, the lumpy skin disease had a negative impact on milk production growth, resulting in a near-zero growth rate in FY23 compared to the usual 5 to 6% growth rate in a normal year.
      • Secondly, there has been high inflation in fodder prices, ranging from 20 to 30% in recent months. These factors have strained milk prices, and it is unlikely that prices will decrease in the current fiscal year under normal circumstances.
    • Solution: Reducing import duties on fat (butter) and skimmed milk powder (SMP).
      •  Currently, the import duty on fat is 40%, and for SMP, it is 60%.
      • It is argued that Indian prices for SMP and fat are much higher than global prices.
      • By lowering the import duties to around 10 to 15%, it is expected that there will be some imports of fat and SMP.
      • This could help in stabilizing or reducing milk and milk product prices.

Beyond Editorial

RBI’s Inflation-Targeting:

Inflation-targeting is Central Bank’s Monetary Policy that aims to keep inflation rate close to an agreed target.

  • Repo rate: The rate at which the central bank of a country lends money to commercial banks.
  • Reverse repo rate: The rate at which the central bank of a country borrows money from commercial banks.
  • Statutory Liquidity Ratio (SLR): Minimum percentage of deposits that a commercial bank has to keep in the form of liquid cash, gold or other securities.
  • Cash Reserve Ratio (CRR): It is the percentage of a bank’s total deposits that it needs to maintain as liquid cash with the RBI.

New Zealand, Canada and the United Kingdom were the first three countries to implement fully-fledged inflation targeting.

Different methods of Inflation-targeting:

  • Hiking interest rates: Central bank can increase the rate of borrowing so that rate of lending is also increased. This can reduce money supply in the economy. Ex: Repo and Reverse Repo.
  • Open market operations: Central bank may conduct open-market operations and sell government securities to institutional investors. This will suck out excess liquidity from the market.
  • Reserve ratio: The central bank may raise CRR and SLR for banks, which mandates them to store excess liquidity without lending. This will reduce money supply.
  • Appreciating domestic currency: It also involves central bank stabilizing currency exchange rate by maintaining a reserve of domestic currency and most tradable currencies.

Inflation-Targeting in India

  • The Union government and the RBI are both in charge of reducing inflation in India. The major authority of inflation lies with the RBI, which has to maintain a certain level of inflation.
  • RBI has a legal mandate to maintain an inflation rate of 4, with a leeway of +/- two percentage points either side.
  • RBI primarily contains inflation by raising interest rates in the economy. As loans become costlier, the demand reduces, which in turn decreases inflation rate. The major impact of this move is that economic growth contracts.

Framework for Inflation-Targeting in India:

  • In 2016, Parliament of India amended the RBI Act, 1934 to change the monetary policy, and introduce an inflation targeting framework.
  • According to the framework, the union government, in consultation with RBI sets:
    • an inflation target
    • an upper and lower tolerance level for retail inflation
  • Accordingly, the target has been set at 4%, with an upper tolerance limit of 6% and a lower tolerance limit of 2%. Every five years, the target and bands are revised.
  • In case the inflation is above or below the prescribed limits for three quarters, RBI has to submit a report to the Union government explaining the reasons for rising (or falling) prices persistently, what will be corrective measures, and an estimate of when the target will be achieved.

Pros and Cons of Inflation-Targeting

Pros Cons
  • Countries that have implemented an inflation targeting framework tend to “maintain regular channels of communication with the public”, thereby enhancing transparency.
  • Inflation targeting allows a country to focus on domestic considerations and to respond to shocks to the domestic economy.
  • An inflation-targeting framework makes the central bank and union government accountable to the people.
  • It will allow businesses, investors, and the government to plan their investments and policies based on prevalent inflation rate.
  • Price stability through better targeting also maintains the purchasing power of consumers.
  • In pursuit of lowering the inflation rate, the Central Bank may raise interest rates to such an extent that demand falls drastically, pushing the economy into recession.
  • There are lags in monetary transmission in India, and over-shooting can have persistent damaging effects, including instability.
  • It does not focus on removing supply bottlenecks or shortages, which are other major contributors of inflation.
  • It is a short term measure that fails to address long-term structural issues.

Efficacy of Inflation-Targeting in India

  • Contrary to the notion of an overheating economy, in India’s case it is the supply costs and bottlenecks that have created inflation and mere raising interest rate would not give much result.
  • Merely raising interest rates may rather prove counter-productive. It may hamper economic growth without actually translating into lower inflation rates. Instead of addressing the demand side of the inflation problem, RBI and the government should focus equally on the supply side.
  • Possible alternatives:
    • Short-term imports: Agriculture and allied sectors are major contributors to inflation as a result of production constraints. To tackle this, supply has to be increased.
      • Allowing imports will remove supply constraints and ensure that agricultural inflation does not percolate into the broader economy.
    • Fiscal policy: The Union government can also contribute towards lowering inflation by reducing excise duties and address supply chain issues.

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