India’s food inflation and linkages with overall inflation trends

Rahul Anand, Ding Ding and Volodymyr Tulin write on the topic.

They say food inflation cannot be ignored as it has wider linkages with overall inflation:

Indian food and fuel inflation has remained high for several years, and second-round effects on core inflation are estimated to be large. This paper estimates the size of second-round effects using an estimated reduced-form general equilibrium model of the Indian economy, which incorporates pass-through from headline inflation to core inflation. The results indicate that India’s inflation is highly inertial and persistent. Due to second-round effects, the gap between headline inflation and core inflation decreases by about three fourths within one year as core inflation catches up with headline inflation. Large second-round effects stem from several factors, such as the high share of food in household expenditure and the role of food inflation in informing inflation expectations and wage setting. Analysis suggests that in order to durably reduce the current high inflation, the monetary policy stance needs to remain tight for a considerable length of time. In addition, progress on structural reforms to raise potential growth is critical to reduce the burden on monetary policy.

There are expectations that policy rates are going to be easier next year onwards. I have serious doubts whether there will be anything like that. India’s case of inflation in recent years has been “multiple bitten, always shy”. Who knows we could be again seeing rate hikes if food inflation again goes awry. Right now there is tremendous amount of good luck supporting Indian economic policy which was absent for few years. The tide could turn once again..

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