The Monetary Policy Committee (MPC) has decided to conduct an off-cycle meeting today to discuss the failure to meet the inflation target under Section 45ZN of the Reserve Bank of India Act, 1934. As per the Reserve Bank of India Act (RBI), 1934, MPC is required to meet at least four times each year, to discuss the macroeconomic issues in the country, and take policy decisions to address those. This is the second time MPC has conducted an off-cycle meeting in 2022-23. The meeting is scheduled in light of inflation being consistently high for nine consecutive months.

In this blog, we discuss what the inflation targeting framework is, examine retail and wholesale prices, and the divergence between them.   

What is the inflation targeting framework, and what happens if inflation is persistently high?

In 2016, Parliament amended the RBI Act, 1934 to change the monetary policy, and introduce an inflation targeting framework. This framework prioritises price stability to achieve sustainable GDP growth. Price stability allows investors to confidently invest their money for productive activities, without worrying about it losing value. Price stability also maintains the purchasing power of consumers, i.e., the ability to purchase a good (or service) with a given amount of money.

As per the new framework, the central government, in consultation with RBI sets: (i) an inflation target, and (ii) an upper and lower tolerance level for retail inflation. The target has been set at 4%, with an upper tolerance limit of 6% and a lower tolerance limit of 2%. The upper and lower limits indicate that although it is desirable for inflation to be close to 4%, deviation between these limits is acceptable. The target and bands are revised every five years. In March 2021, the existing targets were carried forward.  

Retail inflation has been above 6% for the past nine months, and it has been above 4% from October 2019 onwards (See Figure 1).

Figure 1: Consumer price index (year-on-year; in percentage)

image

Sources: Database on Indian Economy, Reserve Bank of India; PRS.

If inflation is above or below the prescribed limits for three quarters, RBI must submit a report to the central government explaining why prices have been rising (or falling) persistently, what will be done to correct that, and an estimate as to when the target will be achieved.   

The MPC uses tools such as interest rates to control the level of inflation in the economy. One such rate is the policy repo rate, which is the rate at which RBI lends money to banks. An increase in the policy repo rate makes borrowing money more costly, and hence is expected to control inflation by reducing the money supply. MPC increased this rate from 4% in April 2022 to 4.4% in May 2022, to 4.9% in June 2022, to 5.4% in August 2022, and to 5.9% in September 2022.

Breaking down the Consumer Price Index and the Wholesale Price Index

Consumer Price Index (CPI) measures the general prices of goods and services such as food, clothing, and fuel over time. Retail inflation is calculated as the change in the CPI over a period of time. Goods and services such as petrol, food products, health, and education are considered for its calculation, which are assigned different weights (See Table 1). Between February 2022 and August 2022, the average annual inflation was 6.9%. The rise in prices of subcomponents of the CPI during this period is indicated in Table 2.

Table 1: Assigned weights for the calculation of CPI

Category

Weight

Food and beverages

46%

Miscellaneous (including petrol and diesel, health, and education)

28%

Housing

10%

Clothing and footwear

7%

Fuel and light

7%

Pan, tobacco, and intoxications

2%

Total

100%

Sources: MOSPI; PRS.

Table 2: Average inflation of some CPI components
between February 2022 to August 2022 (in percentage)

Subcategory of CPI

Average inflation

Vegetables 

13.26%

Oils and fats

12.46%

Footwear

11.41%

Fuel and Light

9.88%

Transport and communication

7.74%

Cereals and products

6.05%

Sources: Database on Indian Economy, RBI; PRS.

CPI is not the only index that measures inflation in an economy. The Wholesale Price Index (WPI) measures the wholesale prices of goods. A change in wholesale prices reflects wholesale inflation. Table 3 indicates the weights assigned to goods for calculating the WPI. Manufactured goods include metals, chemicals, food products, and textiles.   

Primary articles (23%) include food articles, and crude petroleum and natural gas. Fuel and power (12%) include mineral oils, electricity, and coal.  WPI has remained above 10% from April 2021 onwards. It reached an all-time high of 17% in May 2022. This was driven by the inflation in metals, kerosene and petroleum coke, fruits and vegetables, and palm oil.

Table 3:Assigned weights for the
calculation of WPI (in percentage)

Category

Weight

Manufactured products

64%

Primary articles

23%

Fuel and power

12%

All commodities

100%

Sources: Ministry of Commerce and Industry; PRS.

Why has WPI inflation been consistently above CPI inflation?

Movements in the WPI have an impact on the CPI.  For almost a year and half, CPI inflation has remained below WPI inflation.  However, as per the design of the indices, it is expected that CPI would remain above WPI, and that any increase in WPI would reflect in the CPI after a time lag.  This is because retail prices include taxes (as a percentage of price), while wholesale prices do not.  Additionally, some of the goods in WPI act as inputs in the goods considered in CPI.  An increase in input prices would lead to higher retail prices after a time lag.

We discuss possible reasons for why CPI has remained below WPI for a year and a half.

Figure 2: Consumer Price Index and Wholesale Price Index

image

Sources: Database on Indian Economy, Reserve Bank of India; PRS.

Composition of indices

As indicated in Table 2 and 3, the composition of the two indices varies. For instance, prices of manufacture of basic metals, chemicals, and machinery grew at an average rate of 13% between February 2021 and September 2022.  They contribute 7% to the WPI. These are input goods for producing final goods and services such as automobiles, which are included in the CPI. The rise in prices of transport vehicles, communication devices, fuel for transport, and housing (CPI components) rose by 6% during this period.

The Ministry of Finance has observed that wholesale prices did not feed into retail prices (from March 2021 onwards) as wholesalers absorbed the rising input costs and did not pass them on to retailers. In August 2022, it noted that as retail prices are rising now, the pass-through may occur.

The Airports Economic Regulatory Authority of India (Amendment) Bill, 2021 was passed by Parliament on August 4, 2021.  It amends the Airports Economic Regulatory Authority of India Act, 2008.  This Bill was introduced in Lok Sabha during the budget session this year in March 2021.  Subsequently, it was referred to the Standing Committee on Transport, Tourism, and Culture, which submitted its report on July 22, 2021.

Typically, cities have one civilian airport which provides all aeronautical services in that area.  These services include air traffic management, landing and parking of aircraft, and ground handling services.  This makes airports natural monopolies in the area.  To ensure that private airport operators do not misuse their monopoly, the need for an independent tariff regulator in the airport sector was felt.  Hence, the Airport Economic Regulatory Authority (AERA) was established as an independent body under the 2008 Act to regulate tariffs and other charges (development fee and passenger service fee) for aeronautical services at major airports.  

For the remaining airports, these tariffs are determined by the Airports Authority of India (AAI), which is a body under the Ministry of Civil Aviation.  In addition, AAI leases out airports under the public-private partnership (PPP) model for operation, management, and development.  Before AERA was set up, AAI determined and fixed the aeronautical charges for all airports.  It also prescribed performance standards for all airports and monitored them.  Various committees had noted that AAI performed the role of airport operator as well as the regulator, which resulted in a conflict of interest.

The 2008 Act designates an airport as a major airport if it has an annual passenger traffic of at least 35 lakh.  The central government may also designate any airport as a major airport through a notification.  The Bill adds that the central government may group airports and notify the group as a major airport.  Thus, when a small airport will be clubbed in a group and the group is notified as a major airport, its tariff will be determined by AERA instead of AAI.  Note that AERA will not determine the tariff if such tariff or tariff structures or the amount of development fees has been incorporated in the bidding document, which is the basis for the award of operatorship of that airport.

The amendments under the Bill raise some concerns regarding the grouping of airports and the capacity of the regulator.

  • Grouping of airports: The Statement of Objects and Reasons of the Bill states that government will club together profit-making and loss-making airports and offer them as a package in PPP mode to the prospective bidders.  This may be a policy decision to revive loss-making airports.  With the passage of the Bill, AERA will treat a group of airports as one entity.  One of the ways in which tariffs may be structured for the grouped entity would be through cross-subsidies.  This would involve compensating loss-making airports with the revenue generated from the profit-making airports.  If such a model is used, it may increase the cost of services to the end-consumers of profit-making airports or could reduce the profitability of such airports.  The experiences from other sectors such as electricity show that cross-subsidisation may lead to pricing problems in long term. 
     
  • Capacity of the regulator: AERA was created to provide a level playing field in the aviation sector and resolve the conflict of interest that arises with AAI both operating and regulating tariffs at airports.  During the examination of the AERA Bill, 2007 by the Standing Committee, the Ministry of Civil Aviation informed the Committee that AERA should regulate tariff and monitor performance standards only at major airports.  Depending upon future developments in the sector, and as the regulator built its capacity, other functions could be subsequently assigned to the regulator.

As of 2020, there are 125 operational airports in India (includes international airports, customs airports, and civil enclaves).  The number of airports under the purview of AERA increased from 11 in 2007 to 24 in 2019.  For the remaining airports, tariffs are still determined by AAI.  In the last five years (2014 to 2019), air passenger traffic increased from 11.3 crore to 34.9 crore (which is an annual growth rate of 10%).  Till 2030-31, air traffic in the country is expected to continue growing at an average annual rate of 10-11%

Before 2019, an airport with annual passenger traffic of at least 15 lakh was considered a major airport.  In 2019, the AERA Act was amended to increase this threshold to 35 lakh.  The Statement of Objects and Reasons of the 2019 Bill stated that the exponential growth of the aviation sector has put tremendous pressure on AERA, while its resources are limited.  Therefore, if too many airports come under the purview of AERA, it will not be able to perform its functions efficiently.  Consequently, in 2019, the number of airports under the purview of AERA was reduced.  Now, with the passage of the 2021 Bill, AERA will have to again regulate tariffs at more airports as and when notified by the central government.  Thus, the capacity of AERA may be needed to be enhanced for extending its scope to other airports.

Table 1: List of major airports in India (as of June 2019)

Ahmedabad

Delhi  

Mumbai  

Amritsar  

Goa  

Patna  

Bengaluru  

Guwahati  

Pune  

Bhubaneswar     

Hyderabad  

Raipur  

Calicut  

Jaipur  

Thiruvananthapuram     

Chandigarh  

Kolkata  

Tiruchirappalli     

Chennai  

Lucknow  

Varanasi  

Cochin  

Mangalore  

Kannur 

Source: AERA website as accessed on August 2, 2021; PRS.