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The right approach to tackle Indian inflation
Thu, 6 Mar Pre-Open

Balancing growth and inflation has consistently been a challenge for Reserve Bank of India while designing monetary policies

What makes the things more complicated is the what inflation data to target. As we all know, inflation can be broadly categorized into headline inflation and core inflation. By definition, core inflation is headline inflation less food and fuel prices. Due to volatile nature of fuel and food prices, core inflation is generally considered to be a more valuable metric. But is it more relevant for an economy like India where food prices are the major driver of headline inflation and food is a major constituent of an average Indian's consumption basket?

As per an article in Livemint, IMF Research suggests that while focusing on core inflation makes sense in developed economies, it might not be a very efficient approach in the emerging economies. This is because of the different dynamics of food prices in such economies. A study on the inflation in India suggests that it is the core inflation that catches up with headline inflation in the long term. This also implies that impact of food prices is not as transitory as it is assumed. Over a period of time, for an emerging economy like India, food price inflation impacts even the non food inflation. This is mainly because of substantial share of food in household expenditure and the tendency to set inflation expectations and wages around food prices. Hence, targeting core inflation or ignoring food inflation might not turn out to be the best way to design monetary policies.

Given the current state of Indian economy, the central bank needs to control inflation to low and stable levels to ensure meaningful growth. The central bank in recent times itself has given the impression that it is more focused on targeting inflation by keeping the interest rates. However, it should also make sure that it targets inflation that is inclusive of food prices. This may result in high interest rates in the future unless the Government brings in structural reforms to keep food supplies fluid.

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