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Vegetable prices slipped into disinflation in December, something that economists and the RBI had anticipated. (Photo: Mint)
Vegetable prices slipped into disinflation in December, something that economists and the RBI had anticipated. (Photo: Mint)

After December relief, a complicated inflation outlook awaits RBI

  • A stubborn core inflation has been a bugbear for monetary policy for a while now and bringing it down is a big challenge. The RBI risks hurting growth if it chooses to respond to core inflation but it cannot ignore inflation given its adverse effects in the long term

MUMBAI: With December witness to the expected sharp drop in headline retail inflation, markets have gotten the much needed relief but it may be too soon to rejoice as new pressure points are building up.

Headline consumer price index inflation fell to 4.59% in December, having uncomfortable staying 6% for eight straight months. The main contributor to this decline was a big fall in vegetable prices and a favourable base. Vegetable prices slipped into disinflation in December, something that economists and the Reserve Bank of India (RBI) had anticipated. This led to food inflation coming down by 5.02 percentage points. This disinflation is expected to continue in January as well before the base effect wears off, according to economists.

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But that is all there is in terms of good news on headline inflation. Upside pressures from various corners, some within food inflation as well, have begun to emerge. This complicates the outlook on inflation for policymakers. Even as food inflation seems to have declined, driven by vegetables, cereals, sugar, and meat, prices of other items are yet to ease. For instance inflation in edible oils and fruits has increased and despite the overall fall, inflation in sugar, fish and meat remains in high double digits.

The most worrying pressure point is the rise in global crude oil prices and commodities such as gold and silver. The rise in oil prices coupled with domestic taxes on fuel may push up inflation there. Fuel inflation by nature spreads as it permeates every item as the cost of transporting goods. Economists at Barclays estimate that every $10 per barrel rise in crude oil prices pushes up domestic headline inflation by 34 basis points. One basis point is one-hundredth of a percentage point.

"The early data for the month of January 2021 reveals contrasting underlying forces for food items, with a continued plunge in vegetable prices, juxtaposed with a broad-based rise in prices of other food items, especially edible oils. Additionally, the hardening prices of crude oil, and its partial transmission into domestic retail prices, remain a concern," said Aditi Nayar, economist at ICRA Ltd, in an email.

What’s more is that core inflation, more relevant for monetary policy since it is a measure of demand, has eased albeit modestly. Core inflation in December remained above 5%. A stubborn core inflation has been a long standing bugbear for monetary policy and bringing it down further is a big challenge. The central bank risks hurting growth if it chooses to respond to core inflation. But at the same time, the RBI cannot ignore inflation given its adverse effects in the long-term if it gets entrenched. Then there is the mandated inflation target of 2-6% to be met.

Ergo, economists expect the RBI to remain on a long-drawn pause until more clarity on inflation emerges. As such, the central bank expects inflation to be 5.8% in the fourth quarter of FY21, higher than the 4% midpoint of mandated inflation target. A policy tightening may not be warranted but the RBI has got a good reason to continue with its intent to withdraw liquidity stimulus in the coming months.

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