Informist, Tuesday, Apr 23, 2024

--RBI paper: Headline inflation reverts to core CPI, not vice versa

--RBI paper: Fuel inflation less volatile, but impact on core CPI big

--RBI paper: Food shock impact on core inflation reduced over time

--RBI paper: Need to regularly assess fuel shock impact on core CPI
--RBI paper: Need to regularly assess food shock impact on core CPI

NEW DELHI – The impact of fuel inflation on core inflation has turned significant of late, even as the segment's volatility has reduced, a paper by Reserve Bank of India staff released today said. The article was published as part of the RBI Bulletin for April, and does not necessarily reflect the views of the central bank.

"...our results suggest that the impact of food shock on core inflation has reduced over time," the paper said. "However, the response of core inflation to fuel price shock becomes significant and large during global uncertainties."

Tensions between Iran and Israel have intensified significantly this month following the former's accusation that Israel killed Iran's military commanders in an attack on the Iranian consulate in Syria. On Apr 14, Iran launched over 300 missiles and drones towards Israel. In retaliation, Israeli missiles reportedly hit a site in Iran on Friday. Crude oil prices have fluctuated wildly as Iran produces 3.3% of the world's crude output.

The paper assessed the second-round effects of food and fuel price shocks on headline inflation. As shown in past research, the authors--from the RBI's Department of Economic and Policy Research--concluded that headline inflation trends towards core CPI inflation, not the other way around. Non-core components of CPI-based inflation still converge with core components of the basket in the post-COVID era of supply side shocks, an RBI staff paper had said in February.

While headline inflation has averaged 5.2% in Oct-Mar, core CPI inflation that excludes from the headline index food and fuel, whose prices are considered volatile, averaged 4.1% in Oct-Dec and 3.4% in Jan-Mar. In March, core CPI declined to 3.3%, its lowest in the current series with 2011-12 (Apr-Mar) as a base.

Food and fuel components make up around 53% of the weight of the CPI basket, the paper said. Core inflation has become less responsive to supply shocks, as the persistence of these shocks has come down. This shows the benefits of anchored inflation expectation under the flexible inflation targeting framework, which was adopted in 2016, the paper said.

"The inflationary impact of a food price shock may not be transitory when inflation expectations are high and not well anchored," the paper said. Under the framework, the RBI's target for CPI inflation is 4%, within a band of 200 basis points on either side. While CPI inflation has ruled above the 4% target since September 2019, it also topped the 6% upper band of the tolerance band for three consecutive quarters in 2023.

Finally, the paper said a regular assessment of the pass-through of food and fuel shocks must take place for a better informed policy approach. This was pertinent in the current environment of high global uncertainty, a shift in climatic conditions and recurring large supply shocks, the paper said. End

Reported by Aaryan Khanna

Edited by Akul Nishant Akhoury

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