One of India’s problems is that, despite its growing wealth, it struggles to adjust its policies accordingly. The economic framework, designed for when India was a much poorer country, constrains and limits growth. This is particularly true of food prices and monetary policy. Bloomberg News recently reported that the government may restructure the way price increases are measured. This would provide a chance to break out of the growth straitjacket; bureaucratic conservatism should not let India miss this opportunity.

The authorities are depressingly reticent to have anything to do with food production and prices, because these are particularly politically sensitive issues. But they are now absurdly outdated. India’s farm subsidy framework, for example, was developed in the 1960s to boost domestic grain production. That may have been appropriate for a post-colonial country suffering from famine. But it is not right for an industrialising country with food surpluses that needs stable vegetable prices instead.

Policymakers face a variation of this dilemma when it comes to money supply targeting. About a decade ago, the Reserve Bank of India was officially mandated to target an inflation rate of 4%. Since then, the country – which once faced major inflation fears – has largely succeeded in keeping prices under control. This was underlined earlier this week when the consumer price index for July was released. It showed inflation was below the RBI’s target and at its lowest level since before the pandemic. Understandably, few want to change a system that appears to be working.

But that may be necessary. The government’s chief economist argued in his policy paper last month that it would make sense to exclude food prices from the central bank’s inflation target.

His argument was simple but compelling: monetary policy cannot solve supply-side problems. It is designed to address short-term problems with aggregate demand. Yet food prices in India are a response to various rigidities in the economy, all of which are related to the supply side. Grain prices depend on how much the government has to pay farmers. Supply chains for vegetables and proteins are fragmented, leading to wild price fluctuations in response to temporary problems in availability and transportation. The chief economist’s argument is therefore quite understandable.

The cost of ignoring his argument is high. Because the RBI targets an inflation index that includes volatile food prices, it consistently keeps rates higher for longer than necessary. Core inflation – excluding food and fuel – has been well below the 4% mark for some time. But the central bank has not cut rates because Indian food prices are higher than those of other countries. In recent weeks, food inflation has fallen not thanks to a change in policy or demand, but only because a summer heatwave has abated. Still, we will probably have to wait a few more months for a response from the central bank. The RBI’s rate-setting panel has now met nine times in a row without a cut. Every week that an economy short of investable funds has to endure a higher-than-necessary real interest rate can be measured in lost profits, growth and jobs. The argument against change is equally simple: as long as food prices affect Indians’ expectations of future inflation, they cannot be excluded from the RBI’s calculations. This is essentially what the central bank governor stressed last week. He fears that the RBI’s credibility depends on it responding to the general price level, not just core inflation. That is true. But the governor has also made a fatal, false assumption. That is, that India’s consumer price index, and hence its mandate, gives food prices an appropriate weight. In fact, the index – based on surveys from 2011-12 – gives too much weight to food, which makes up 45 percent of the basket of goods. Like agricultural policy, its composition reflects the idea that India is little more than a subsistence economy. With each passing year, that view is more outdated.

India’s consumer price index does indeed need to be restructured, and urgently. Many of the emerging economies that also target inflation are doing better than we are. Take Indonesia, for example. It has similar problems with volatile food prices, but food also has a much lower weight in the country’s consumer price index. And, more importantly, that weight is constantly being adjusted to reflect reality. Every few years, statisticians examine actual household consumption in hundreds of cities and reweight the index accordingly. That is certainly not too much to ask of their counterparts in New Delhi and Mumbai.

If we don’t do that, India will continue to have a central bank that guides its monetary policy on a price index over which it has half no control. Is it any wonder that the RBI is constantly lagging behind?

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