Former Reserve Bank of India Governor Raghuram Rajan has cautioned against excluding food prices from headline inflation. This, he said, would erode the ‘great faith’ of people in the central bank, which has been mandated by the government to keep inflation in check.

Justifying his stance, Rajan said it is best that inflation target a basket which is what the consumer consumes. This affects the consumer’s perception of inflation and ultimately inflationary expectations.

“When I came into office, we were still targeting PPI (producer price index). Now that has no bearing to what the average consumer faces.

“So, when the RBI says inflation is low, look at PPI, but if the consumer is facing something very different, then they do not really believe that inflation is down,” Rajan told PTI in an interview.

Rajan was responding to a question on suggestions made in the Economic Survey 2023-24 for excluding food inflation while setting benchmark interest rates.

“So, if you leave out some of the most important parts of inflation and tell them, inflation is under control, but food prices are going to the roof or something else is going up, which is not included in the inflation basket, then you know, they would not have great faith in the Reserve Bank,” he said.

In the Economic Survey 2023-24, India's Chief Economic Advisor V Anantha Nageswaran argued for excluding food inflation when fixing benchmark interest rates. According to him, monetary policy has limited influence over food prices, which are largely dictated by supply-side factors.

Rajan, who is currently a professor of finance at US-based Chicago Booth, said the argument against excluding food inflation is that ‘you cannot affect it’.

“You cannot affect food prices in the short run, but if food prices stay high for a long time that does imply there are constraints on producing food relative to the demand, which means to balance that you have to bring down inflation in other areas, which is what the central banks can do,” the eminent economist told PTI.

According to Rajan, the RBI can target the aggregate price level.

The weightage of food in the overall consumer price inflation, which stands at 46% currently, was done in 2011-12, and needs to be revisited.

India introduced the inflation-targeting framework in 2016 under which the Reserve Bank of India (RBI) is mandated to keep retail inflation at 4%, with a margin of 2% on either side.

The benchmark policy rates are decided bi-monthly by the RBI on the basis of movement in consumer price index, which includes food, fuel, manufactured goods and select services.

The RBI projects retail inflation for 2024-25 at 4.5%, lower than 5.4% in the last fiscal.