Food inflation may well eat into rates

Headline inflation has spiked on an episodic surge in vegetable prices. There is also an underlying momentum to food prices with uneven progress of the monsoon. Cereal prices have been defiantly elevated for the better part of the year, despite several supply-side interventions, including export bans. This is an area of concern because rice and wheat stockpiles offer the widest scope for intervention to cool prices. Dairy prices have a strong correlation to those of cereals that go into cattle feedstock, and second-order effects are on display. Prices of pulses are increasing as India enters the international market to make up for domestic undersupply. Food-price inflation confronting India is not idiosyncratic. There are chronic factors that need to be addressed.

This calls into question RBI‘s assessment that episodic spikes in food inflation, unless very frequent, do not require a deviation from its monetary-tightening trajectory. Segregating the supply-and-demand side effects of inflation allows it to steer the economy to a soft landing. The evidence is softening core inflation – which factors out volatile food and energy prices – although it is still a percentage point above the 4% target set out for inflation based on CPI. Ancillary evidence is provided by WPI with a bigger weight to manufacturing, which is on a deflationary course.

Yet, if food inflation is neither as idiosyncratic nor as easily amenable to supply-side measures that the central bank’s rate-setting committee assumes, the shape of the interest-rate upcycle could become significantly different. Persistent food inflation imposes an extra onus on monetary demand compression. A faster reduction in core inflation builds a bigger cushion against recurrent surges in food inflation.