Home >Markets >Mark To Market >A tale of two lockdowns and RBI’s CPI inflation problem

Inflation is back at the centre of discussion in markets and among policymakers. Amid an ongoing pandemic, this is a déjà vu event. Déjà vu events may be unpleasant but they bring in the opportunity to learn from the first one.

The surge in India’s retail inflation in April to an uncomfortable 6.3% has many similarities and some differences in comparison to a similar situation last year. Since the year-on-year rate of price increases come with a big statistical base effect, analysts recommend looking at the momentum of the rise this time. The adjoining chart from independent research firm QuantEco shows the momentum of inflation currently and last year.

What is clear is that just like last year, the rise in prices is broad-based. Almost all components, from food to fuel and core have risen and contributed to the rise in the headline print. But it gets interesting as we observe each component and the behaviour.

Food inflation this time shows an almost identical increase in momentum of last year and the factors behind this are also similar. Seasonal price pressures as summer give way to monsoon, and some supply disruptions due to lockdowns explain almost all of the increase here.

The second troubling spot is fuel. Some differences creep in here compared with the experience last year. The rise in the momentum of fuel price inflation is more this time and that is a reflection of the surge in global commodity prices. But the key difference in what drove fuel price inflation this time is taxes.

Retail prices of petrol and diesel have shot up recently, and more than half of the increase is simply due to excise duty hikes. Hamstrung on direct tax revenues, the government has little choice but to rely on indirect taxes such as excise duties. It has chosen to rely heavily on them.

What’s more is that the month-on-month increase of 2.09% in fuel inflation was also driven by rising prices of dung cake, firewood and chips, and electricity besides the crude oil derivatives, QuantEco analysts point out. This shows that fuel inflation cannot be attributed to only taxes or even global commodity price boom. Fuel inflation is the biggest headache for the RBI now because this segment permeates all other parts of the economy through transportation cost.

The third and the surprise element is the stronger-than-before rise in core inflation. The momentum in services has been higher than last year and the increase from health can be explained through the impact of the second wave. But the rise in prices of household goods and services could be due to producers passing on input costs.

What are the implications of these similarities and differences for the RBI?

Analysts at HSBC point out that the increase in inflation throws a challenge to the RBI’s policy focus on growth. “All told, we think the RBI will embark on a gradual normalization path from 4Q2021," the HSBC note said. Those at Nomura too believe that normalisation would begin by the fourth quarter.

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