5 graphs show RBI’s inflation-growth tightrope walk
3 min read 25 Jul 2022, 07:01 PM ISTCan the RBI be as aggressive as it had planned to be when it meets next week?
PremiumFive months into the Ukraine war, the tricky inflation-growth dynamic is taking a turn again. Slowing commodity prices look set to cool inflation—but not soon, and certainly not enough. Meanwhile, a recession looms, posing a dilemma for central banks. Can the Reserve Bank of India (RBI) still be as aggressive as it had planned to be when it meets next week?
As global commodity prices shed the record highs of the early weeks of the war, economists in India forecast some relief on the ultra-high inflation indeed. It will be “a silver lining, especially if oil softens materially," said Dhiraj Nim, economist at ANZ Bank. Barclays economist Rahul Bajoria said in a 12 July report that if sustained, the correction in global commodity prices, including edible oils, precious and base metals, “could act as a moderating influence on headline inflation".
However, the reality is that most of these prices are just about returning to pre-war levels, aided in part by the Centre's measures, and their pace still far exceeds pre-pandemic levels. Inflation is still likely to average over 6% in 2022-23, and the RBI’s monetary policy committee would do well to keep its focus on rate hikes until inflation slows down considerably, analysts said.
Amid fear of a global recession, several international organizations and rating agencies have downgraded India’s growth projections as well. The US Fed may be forced to respond to recession concerns. However, from across-the-board inflationary risks to struggling corporate margins, there are ample reasons why economists feel the RBI should keep the focus on inflation as the main target.
Across the board
A range of inflation components will be on policymakers’ radar. Fuel hinges upon how crude oil progresses. After peaking over $120/barrel this year, the commodity is down but remains in three digits. There are bearish views such as Citigroup’s, which expects it below $65 by year-end if a recession strikes. But JPMorgan sees it around $104 if Russia cuts production in retaliation for sanctions.
Inflation in India would descend only to around 6.9% this fiscal if oil comes closer to $100/bbl, said Nim of ANZ Bank, who otherwise expects it to average 7.2% in 2022-23 on a higher crude oil price assumption. While improved monsoon prospects give a cushion on food, a larger worry for the RBI could be demand-push services inflation. “The sequential momentum in services inflation remains a key thing to keep an eye on," said Aditi Nayar, chief economist at ICRA Ratings. “This is because high domestic demand is likely to push prices up."
Divergent inflation
Moreover, for now, cooling commodity prices will likely be a balm only for wholesale prices. This measure of price rise has been in double digits for over a year, and over 15% since April. Manufacturers across sectors have only lately hiked prices to pass on the pain to consumers.
“We expect WPI [wholesale price index] to slow over the next few months on recent corrections in global commodity prices," said Anubhuti Sahay, economist at Standard Chartered Bank. “However, even as WPI slows, we think some pass-through [of high input prices] to the consumers is [still] likely as producers have passed the input price increases only partially till now."
Household expectations of inflation stay high, with nearly two-thirds of respondents surveyed by the RBI in May predicting inflation faster than the current rate in the following three months, and even more (71%) seeing it worsen over a one-year timeframe. This is the bleakest outlook in nearly a decade.
Policy dilemma
The RBI had jumped on the rate-hike bandwagon only in May as inflation began crossing 7%. With inflation risks still alive, how well is it placed to begin tackling slowdown risks instead?
Kunal Kundu, India economist at Société Générale, said RBI may be better off to stick to rate hikes for a couple of meetings more at least. Bajoria said previous global or US recessionary cycles were accompanied by commensurately falling commodity prices, but on this occasion, supply-side factors still exist. “The war will keep prices up even in a weak growth backdrop," he said. “That’s why it becomes more important for RBI to take that hit on the monetary policy side in terms of hiking rates."
While corrections in essential commodities give some breathing space, existing volatile factors remain decisive as long as supply chains remain disrupted and a global economic slump looms. The RBI will closely monitor these developments.
