Food is hot...

The inflation reading for July (the latest) show breaching of the inflation target for this year and risks even the next year’s target, has made the RBI and the Government shift the goalpost to the next few years, instead of 2018. Now, the inflation target for the coming five-years is 4% with a band of +/- 2% given the high food-inflation experienced almost every year. The prices of one or more basic food items catch fire each year. Food and fuel are important from the point of view of inflation and volatility, and have a higher weightage in the inflation index. However, low fuel cost in the near past made the inflation target achievable even when food inflation remained high and the government imported pulses on a large scale to cool-down its domestic prices. The two successive droughts in the past years have worsened the food inflation and lowered the rural demand and growth. At one place income has come down and at other higher inflation has gone up which have kept real incomes lower in the rural areas when the economy is still recovering from a downturn. Inflation too is responsible for lower demand and growth because it reduces demand for other G&S.  Nonetheless, hope of a good monsoon and lower food inflation comfort the economy in terms of lower expected inflation and interest rates on the account of the credibility established by the RBI to check inflation and inflationary expectations in the past. The RBI sacrificed growth to contain inflation and has now an inflation target out of which it is expected to tighten and below which it would lower interest rates. Like rate-cuts, rate-hikes could also be delayed in expectation of lower prices adjustments. The central banks indirectly manipulate interest rates through money-supply and the RBI has committed a liquidity-neutral stance which also means the natural-rate at which there is neither inflation nor deflation, if there would be surplus liquidity there would be inflation or when there is a deficit there would be deflation. INDIA is yet to achieve that rate, but food inflation is a volatile category which requires more supply and that is determined by a number of variables other than interest rates like weather, trade-restrictions and farmer’s welfare. Deflation should be considered different from disinflation. Opposite of the developed-world in deflationary pressure, INDIA is going through disinflation. Deflation occurs when the price-level go below the base year. However, when there is scope for imports to cool down domestic inflation and lower interest-rate, the government could bring out tenders and might provide interest-rate subvention which would help bring the overall inflation and interest-rate down…