Is India ahead of 'unacceptably and uncomfortably high' phase of inflation?

The state of the economy report authored by RBI staff said the fall in the inflation rate in July was a heartening development

The retail price inflation has declined for the last three months till July even as it remained over the mandatory threshold limit of six per cent, set by the monetary policy committee (MPC) of the Reserve Bank of India (RBI). If it remains over six per cent for two more months the RBI will have to explain to the government in writing the reasons for its failure to contain the inflation rate below the threshold limit, besides a couple of other suggestions and time frame.

Looks like both the RBI and the government seem to be suggesting that the inflation rate would now be coming down even as it remains quite high at present. Experts concur with optimism.

Bank of Baroda Chief Economist Madan Sabnavis said, "Yes, it does look like the worst of inflation is behind us with crude and metal prices cooling off."

Icra Chief Economist Aditi Nayar also said, "We do believe that the CPI inflation peaked in Q1FY23."

The average inflation rate rose to 7.28 per cent in the first quarter of the current financial year against 6.34 per cent in the fourth quarter of FY22. The rate was the highest at 7.79 per cent in April in this calendar year so far (till July).

Nayar said inflation may, however, rise in August and September relative to July 2022 on the back of an unfavourable base.

The inflation rate came down from 5.59 per cent in July 2021 to 5.30 in August 2021 and then further to 4.35 per cent in September in the same year.

Sabnavis said, "Hence our fight with inflation threat will be more statistical as the base effects will manifest in inflation cooling off or not."

Sabnavis, however, cautioned that one has to wait for the post-monsoon syndrome of onion, tomato, and potato crops prospects, which can derail this movement. "But that we will get to know that in October or so," he said.

Nayar nevertheless expected the inflation rate in Q2 to undershoot the MPC's projection.

MPC projected the inflation rate to average at 7.1 per cent in Q2. The first month of that quarter — July — saw the inflation rate coming down to a five-month low of 6.7 per cent from 7 per cent in June. MPC's projection for Q2 means that the average inflation rate would be 7.3 per cent in August and September, which does not seem the case at present.

MPC based its projection on the assumption of a normal monsoon in 2022 and an average crude oil price (Indian basket) of $ 105 per barrel.

Global crude prices (Indian basket) fell to $97.19 on an average in August till 18th from $105.49 in the previous month.

The country got 15 per cent less-than-normal rainfall between June 1 to August 15, according to the latest figures. Uttar Pradesh has received the least rainfall among all the states.

Nayar also said, “if the downtrend in commodity price sustains, we expect some softening in output prices around the festive season. However, we remain cautious regarding the lag in rice sowing and the momentum in services prices, given the robust demand for the latter."

As can be seen from the chart, while food inflation fell to 6.75 per cent in July from 7.75 per cent in June, core inflation (which takes out food and fuel inflation) rose to 6.3 per cent from six per cent over this period. While fuel and light inflation also rose to 11.76 per cent from 10.14 per cent, it may come down in the coming months due to falling international crude prices.

 

However, RBI Deputy Governor Michael Debabrata Patra said at MPC that the elephant in the room is the unrelenting strength of the US dollar, which has risen by over 8.3 per cent since March 31, 2022.

The deputy governor noted that during the financial year 2022-23 (up to August 3), the Indian rupee fell by 3.9 per cent against the US dollar — 4.4 percentage points less than the MSCI advanced economy currency index and 1.3 percentage points less than the MSCI EME currency index (5.1 per cent).

Recently a top policymaker said with commodity prices easing due to fears of a recession in advanced economies, the concerns regarding runaway inflation have abated.

“At any point in time, different aspects of the economy have to be monitored, and we are closely monitoring inflation. Steps have been taken to bring down prices of essential items, which are showing results,” the official said.

According to the minutes of the meeting, RBI governor Shaktikanta Das said the inflation rate was "unacceptably and uncomfortably" high, as he along with other members proposed a 50 basis points hike in repo rate at the last policy review with a view to preventing its upward drift from the target.

However, the state of the economy report, authored by RBI staff including Patra, released earlier this month said the fall in the inflation rate in July was a “heartening development” and it may ease to 5 per cent by the first quarter of the next financial year before hitting the target of 4 per cent.

“Perhaps the most heartening development in recent times has been the easing of inflation in July 2022 by 30 basis points from June 2022, and an appreciable 60 basis points from the average of 7.3 per cent for Q1:2022-23. This has validated our hypothesis that inflation peaked in April 2022,” it added.

The report does not necessarily reflect the views of the RBI.