Are pricey vegetables taking a toll on Indian bank stocks?

Is high food inflation the reason for the relative underperformance of bank stocks?Over the past year, Bank Nifty is up 14.5%, whereas Nifty 50 has risen nearly 30%. With the US Federal Reserve completely pivoting towards lower rates, one would expect bank stocks to power ahead in such a scenario. But that is not happening. This is due to the Reserve Bank of India’s (RBI) reluctance to indicate any reversal in its hawkish monetary policy stance. Two members of the Monetary Policy Committee have argued for lower rates to ensure potential growth is achieved.The government’s top-most economist, chief economic adviser V Anantha Nageswaran, has argued that when food inflation is driven by supply shocks and cannot be controlled by monetary policy, then why not drop it as a variable in the monetary policy framework.There is also an argument that the current weight of 45.9% for food and beverages in India’s Consumer Price Index (CPI) is way too high and needs to come down. For instance, food items have a weightage of 13.41% in the US CPI basket and 31.8% in China’s CPI basket. In Brazil’s CPI basket, food and beverages have a weightage of 26%.The government has already started an exercise to review the way CPI is calculated in India, which will entail removing certain redundant items from the calculation and adding the relevant ones.A reduction in weightage to food and beverages is also expected alongside the change of the base year for CPI calculation to 2024 from 2012.A 10-percentage point reduction in weight to food and beverages, for instance, would reduce headline inflation by nearly 1 percentage point in the present circumstance. That would provide significant headroom to the RBI for cutting rates.Globally, the European Central Bank, Canada, Switzerland and Sweden among advanced economies and Brazil, China, Mexico, Chile, Hungary and the Czech Republic among emerging markets have already started cutting interest rates. But the RBI’s reluctance to align its monetary policy with dovish central banks comes from the fact that higher food prices can lead to generalised inflation. But what does one do when food inflation becomes almost permanent?“What the government can probably do is adjust the weightage of items in the CPI basket to have a better view rather than just excluding food items from the monetary policy framework when it is amended,” says Madan Sabnavis, chief economist, Bank of Baroda.Food inflation: higher for longerIndia’s core inflation, which strips out volatile food and fuel items, has been below 4% for eight consecutive months since December 2023. Headline inflation, which came in at 3.54% in July mainly due to base effect of last year, has been higher than core inflation due to elevated food prices.The RBI’s own analysis shows that food inflation has become persistent and endemic. Food inflation has averaged 6.3% during the 2020s, which is a stark contrast to the 2016-20 period when it averaged just 2.9%.“The broad-based and persistent food inflation that has taken hold during the last four years as a result, belies the conventional notion of food inflation pressures being sector or crop-specific localised factors and transitory,” RBI’s Michael Debabrata Patra, Joice John and Asish Thomas George wrote in an August 19 paper titled ‘Are Food Prices Spilling Over?’“In fact, a deep dive into food inflation behaviour in the 2020s shows that high food inflation has become endemic,” they wrote. medium112986632Their analysis reveals some interesting points:In a staggering 57% of months between June 2020 and June 2024, food inflation was at or above 6%.Barring sugar and confectionary, all other food sub-groups experienced high food inflation in more than one-third of the months considered.Vegetable price spikes are generally assumed to be transitory, but double-digit inflation was experienced in this category in 22 out of the 49 months.Double-digit inflation has occurred for 24 months in respect of pulses and oils and fats (ie, in 49% of the months considered).Extreme inflation pressures of 20% or above have been observed in vegetables, oils and fats, and spices food sub-groups.The authors argued the need for higher policy rates as food price pressures persist and continue to spill over.New inflation-targeting frameworkWhile the RBI is concerned about high food inflation coming in the way of its mandate to maintain price stability, there is also a valid argument to cut rates when aggregate demand is lagging overall growth and elevated food prices become an almost permanent feature.“There are primarily three components to food inflation: transitory, structural and administrative. And all these components are outside the realm of monetary policy. When food prices started rising sharply in 2022, the government took more than two dozen measures to quell food inflation,” a finance ministry official told ET Prime.Even as the Economic Survey 2023-24 has advocated that India’s inflation-targeting framework should target the inflation rate excluding food, the government thinking seems to be around reducing weights for food and beverages rather than just excluding them when it revises the monetary policy framework and mandate for the RBI. medium112986659“We have observed that high food inflation leads to elevated core inflation through the higher wage-led excess demand route, pushing up inflation expectations of the household. Even when CPI inflation is around 4-5%, household inflation perceptions are always around 7% or 8%,” says Sabnavis.He says even globally no central bank targets just core inflation. “Every central bank targets headline inflation. So, going against the world view to look at only core inflation in India, excluding food items, maybe a rather unconventional approach to monetary policy.”The RBI projects CPI inflation of 4.5% for 2024-25, giving an average real repo rate of 2%. The apex bank’s target range for CPI inflation is 2-6%, with the target at 4%-plus or minus 2%.Monetary Policy Committee members Ashima Goyal and Jayanth R Varma have argued for cutting rates by 25 basis points, as high real rates are leading to growth sacrifice and preventing India from its potential growth rate of around 8%. Also, India’s aggregate demand continues to lag GDP growth — expanding at half the rate of overall growth and per capita consumption growth is at a 12-year low.The final cutThe banking sector is the lifeline of an aspiring economy like India. And an adequate level of interest rates is required to achieve potential growth rates. While excluding food items from the inflation-targeting framework may look like an extreme move, lowering their weights in the CPI could help balance the twin goals of benign rates and price stability.