If inflation remains elevated, RBI will be forced to undertake sharper monetary policy adjustments

• Recently the data, released by the National Statistical Office (NSO) showed that retail inflation, as measured by the consumer price index (CPI), rose to a seven month high of 6.01 per cent in January, up from 5.66 per cent in December.
• This is the first time since June last year that inflation has come in above the upper limit of the inflation-targeting framework of the RBI.

Findings of the data

• Food inflation rose to 5.43 per cent in January, up from 4.05 per cent in December.
• Food inflation has risen considerably in the recent past, in October last year, the consumer food price index was at 0.85 per cent.
• In the last month items such as cereals, meat and fish, milk products, vegetables witnessed a rise.
• Worryingly, core inflation, which excludes the highly volatile food and fuel prices, has continued to remain elevated with price pressures being witnessed across categories such as household goods and services, and clothing and footwear.
• This is perhaps indicative of a pass-through of higher input costs
• The wholesale price index has remained in double digits for the last 10 months.

Future prospects by RBI

• RBI expects retail inflation to peak in the fourth quarter of this fiscal year, trending downwards thereafter, creating space for its continued accommodative stance.
• It has projected CPI at 4.5 per cent in 2022-23, with inflation averaging just under 5 per cent in the first half of the year, followed by 4.1 per cent in the second half

Risks associated

• Crude oil prices: Brent crude oil is currently trading at upwards of $90 per barrel.
• Higher crude oil prices will likely be reflected in higher prices at the pumps, passed on to the consumers, once the state elections are concluded.
• Unless the government offsets the price rise with cuts in fuel taxes.
• Contact-intensive services: With restrictions on economic activities being eased, these services may also see price pressures.
• Higher input prices: As domestic demand strengthens, the pass-through of higher input prices to consumers may gain traction.
• Imported inflation: With inflation in developed countries also rising, there is the risk of importing high inflation.

Why Persistent High inflation is bad for the economy

• Private Investment: To fight the rising inflation, Interest rates may be increased, which increases the cost of borrowing and may crimp investment.
• It could raise the cost of financing for investment and consumption activities, and thereby compress aggregate demand.
• High inflation may lead to a decline in demand especially from individuals on fixed incomes (such as salaried and Pensioners) which lead to a decline in private investment.
• Rising inflation in an economy may lead to a flight of capital as FII may take their money out (as the real interest rate in the economy declines).
• It discourages capital inflow in the economy. Lack of adequate capital at a cheaper rate discourage private investment.
• Similarly, High inflation is unstable. There is uncertainty about future rates of inflation, which reduces the efficiency of investment and discourages potential investors.
• External Sector: Rising inflation results in an increase in input prices of commodities which eventually increases prices of final products.
• Rising prices may, thus, impact the competitiveness of Indian export products in the global economy leading to a decline in exports
• It leads to the appreciation in the real effective exchange rate (REER), which may again weaken the export growth in the country
• Increase in input cost may result in a decline in the profit margin of the domestic firms (if the firm chooses not to increase prices of product).
• Fiscal Imbalance: With rising inflation, the government may be forced to increase subsidies (increase in food subsidies, fertilizer etc). This may delay the fiscal consolidation path and increase the Fiscal Deficit of the country.
• Affects tax collection of the government.

Conclusion

• With food accounting for two-thirds of household budgets, higher prices will worsen demand for non-food goods.
• At a time when consumption expenditure data shows rising poverty along with declining wages, climbing inflation will only lead to increased vulnerability, while making an economic recovery harder.
• In this context, RBI’s sole mandate of inflation targeting requires a relook and in the broader scheme of things, there is a need for synchronization of the fiscal policy with monetary policy.
• This may help the government to avert the condition of high inflation before it has a detrimental impact on Indian Economy.