Inflation is now the b u z z wo r d – b o t h domestically as well as globally. While inflation in US is 8.3%, in India it hits 7.79% (CPI) last month. Interestingly, a year-on-year (YoY) comparison shows that while in April 2021, the rural inflation was relatively less than urban inflation, in April 2022 (provisional) and March 2022, the rural inflation shows higher trend than the urban inflation. However, a monthly comparison shows that while from March 2022 to April 2022, urban inflation has increased to 1.62%, rural inflation has increased to 1.24%. Item-wise YoY inflation trend shows that in April 2022, prices of ‘oils and fats’ has increased 17.28%, ‘vegetable’ prices have increased by 15.41%. These two item categories have increased substantially. As fallout of the Russia-Ukraine war, edible oil (sunflower oil) supply has been adversely impacted. Sunflower oil supply from Ukraine and Russia got disrupted due to Russia’s invasion of Ukraine. On the other hand, supply from Indonesia got subdued due to lower exports and soy oil from South America has not increased much due to drought. India purchases on an average 17 lakh tonne of sunflower oil from Ukraine, 5 lakh tonne from Russia and 3 lakh tonne from Argentina.
The Russia-Ukraine war has also generated a shortage of potash, a major ingredient used in manufacturing of fertilizer. Russia, Belarus are major sources of potash suppliers to India, and India imports some amount of potash from Russian ports, due to sanctions such supplies might be impacted. Certain Potash miners in Canada are also not keen in raising potash production; thus prices are also not getting moderated. Such developments might push up p o t a s h p r i c e s , hence might force the Government of India (GoI) to provide for more fertiliser subsidy. According to the RBI MPC minutes (22 April 2022), the external sources of inflation have a much broader role to play in generating domestic inflationary pressures. As pressures on oil prices persist, pump prices began rising steeply in the end of March. Further, edible oil and wheat prices have also firmed. Also, we have to acknowledge that while repo rate hike is largely a demand-compressing measure to reduce inflation (forced savings), without addressing supply side issues and certain fundamental issues, RBI policy would not be very effective in controlling overall inflationary pressures in the long-run.
For instance, during April 2020, when global oil price was in negative territory, Indian oil prices did not decline due to structural reasons, e.g. high historical excise duty collections, dealer’s commission, State level VAT etc. Moderation of excise duty was not substantial enough to reduce the repercussion effects in recent times and this (if any cut) should follow economic reasons, not for political reasons. Inflationary Expectations Survey by RBI reveals that 89.9% respondents in March 2022 believed that prices will increase going forward, higher than the January 2022 estimate (85.6%). More people believe that prices will increase further (more than the current rate) [67.2% in March 2022 compared to 61.4% in January 2022]. Further, while 89.6% in March 2022 believes that food inflation is not going to soften, which is higher than the January’2022 estimate (83.7%), 88.4% believes in March 2022 that non-food prices will also increase compared to January 2022 estimate(80.4%). The same is true for other categories like cost of housing, services categorythus indicating an overall higher household inflation expectations going forward. Now, the recent repo rate hike to 4.40% by the RBI, and more rate hike in the offing, many banks have increased their external benchmark based lending rate, as such banks also face upward pressure on their deposit rate. As NBFCs use prime lending rates, costlier than repo-linked rates charged by banks, there might be some refinancing /re-pricing attempts by customers, but some loan balance transfer may entail higher cost (processing fees, legal and mortgage registration fees). For NBFCs also borrowing costs might increase.
Th e Rupee on 9 May 2 02 2 reached lowest at 77.58/$ as dollar index gained strength; due to a combination of factors – strong dollar index supported by Fed rate hike (no market surprise by Fed, it was well preannounced that market factored in) unlike RBI that have certain ramifications on market. The 10 year US treasury crossed 3%, equity market remain nervous amid record FPI outflows, domestic bond market seeing surge in 10 year benchmark yield of around 7.40%. Higher US interest rates with policy stability might have a pull-out factor by FIIs from emerging markets including India, which is a reason for weakening rupee. There is also some downtrend of RBI’s forex reserves, that declined below $600 billion which also shows that RBI is intervening in forex market to stabilise Rupee’s value vis-à-vis USD. While both Fed and RBI has been criticized as “behind the curve” amid surging inflation, RBI has surprised the market in respect of “timing” while Fed is following whatever it had indicated to the market earlier. Inflation is a complex issue.
Sometimes it is coming through food supply channels (onions, edible oils etc), energy, more worryingly, inflationary expectations are high, which would not lower, if policies are not credible. Increasing repo rate is basically a demandcontrol measure, but for addressing supply side issue, there are two aspects: [1] Internal factors that are under control of the GoI [2] External factors that are not under control of the GoI (e.g. global commodity inflation, supply chain disruptions, semi-conductor issue, energy issue, oil & gas issues, lack of many crucial raw materials etc; emanating from geopolitical aspects). Internally, we can pursue certain policies that are under the control of the GoI and to ensure that for any policy mistakes the problem should not profligate further. RBI estimates the degree of anchoring by shock and level anchoring. Shock anchoring implies that transitory supplyside shocks and inflation surprises (difference between the realised inflation and prior inflation expectations) do not affect inflation expectations of economic agents.
Level anchoring assesses directly whether inflation expectations are anchored at the inflation target. Based on these, an empirical analysis is undertaken for 4-quarter ahead inflation expectations. It might happen that RBI may revise its inflation projections going forward, but communicating effectively to market will give confidence to the market and economy, especially when household inflation expectations are drifting higher. Further, for fuel-linked inflation and other related supply side issues, the government also has a much proactive role in containing inflation expectations, and for effective tackling of inflationary pressures, a harmonised collaboration between fiscal and monetary policies are imperative.
The author is an Economist at Infomerics