Supply-side reforms and timely revision of inflation index must for monetary efficacy

Global Inflation Isn't Improving, It's Getting Worse

The Reserve Bank of India (RBI) recently faced an unexpected setback to its plans for monetary tightening. The RBI had expressed concern about the stubbornness of "core inflation" during the February policy review, but this narrative has now been reversed. While core inflation has decreased in July, continuing a trend that started in February, the overall inflation rate has reached a 15-month high of 7.44%. This increase is mainly due to a significant rise in tomato prices, which has had a ripple effect on the prices of other vegetables. Additionally, the cost of cereals remains high despite efforts to increase supplies, such as banning the export of white rice. Moreover, the prices of spices and some other items in the food basket have also increased.

Furthermore, the global inflation situation is not improving. This is occurring at the same time as global growth is slowing down after a strong beginning of the year. However, on a local level, the conditions are favorable for economic growth. The difference between actual and potential GDP has become positive in the fourth quarter of the fiscal year 2023, for the first time since late fiscal year 2020. The demand for goods and services is improving across various sectors and is expected to remain strong for the next three quarters. Many indicators that measure economic activity are showing positive results. Investment in fixed assets is gaining momentum, although there has been a decrease in exports. It would be uncomfortable to suppress these emerging trends, but the Reserve Bank of India (RBI) will prioritize maintaining macroeconomic stability and preventing any potential risks. It is evident that the central bank is once again facing a difficult situation regarding economic growth, and the decision to reduce interest rates is being postponed.

There are several things in the area of government policy that need to align more closely with monetary policy. As stated by the RBI in their recent State of the Economy report, the world is expected to experience more frequent and severe effects of climate change, such as rising global temperatures and unpredictable monsoons. This could lead to significant negative consequences for crop yields, including in India. An example of this can be seen in the recent impact on the kharif sowing patterns in north and northwest India due to early monsoon arrival and subsequent lack of rainfall since late July. The upcoming rabi crop is also expected to be affected by El Nino conditions. Therefore, it is crucial to implement agricultural reforms that ensure fair prices for farmers and invest in improving supply chains in order to mitigate the shocks to food supply. Additionally, it is important to proactively address supply issues for oil and other essential commodities driven by geopolitical factors by adopting alternative fuels that reduce reliance on imports.

Furthermore, it is imperative that the inflation index and its base year be promptly revised and done so on a regular basis. The consumer price index (CPI), which was created using information gathered over ten years ago, has not been altered in terms of its composition or base year, despite the significant changes in household spending patterns within an evolving economy. Presently, the food price index accounts for almost 30% of the CPI, even though food items that are relevant to a larger portion of the population have a significantly lower representation in the consumption basket. Additionally, consumption has predominantly shifted towards higher-income individuals since the introduction of the CPI. As a result, the index should include a greater representation of the products and services that they purchase, such as newer technology and electronic devices. While it is normal for monetary goals to require occasional adjustments, basing these decisions on potentially unreliable data poses significant risks.