All three RBI officials in MPC have flagged off inflation risks, and external members Shashanka Bhide and J.R. Varma too have chimed in.
Deputy governor Michael Patra and Varma were the strongest voices on inflationary pressures. “Elevated inflation has checked in and may be here to stay," said Patra arguing that retailers are trying to recoup lost income by keeping margins intact or in some cases, even increasing them.
This is logical as the farm-to-table supply chain has seen an increase in margins at most intersections. This juxtaposes with the rise in services inflation. The fact that most listed companies have been able to keep their profit margins intact shows that pricing power has not dissipated. That brings us to the interesting argument by Varma.
Varma said that in sectors that have a core oligopolistic structure and peripheral competition, the core big firms have weathered the pandemic better. “Rising profits and profit margins, improving capacity utilization and lack of new capacity additions create ripe conditions for the oligopolistic core to start exercising pricing power," Varma said. In essence, large companies that provide goods and services may keep prices elevated.
Patra warns that margins won’t compress in the near term. This means that even though headline inflation may trend down—as expected by RBI— inflationary pressures won’t ease.
Varma has also warned that the sharp drop in short-term rates is feeding into asset price inflation. “I believed then and believe now that this reduction of rates carries significant risks and very little rewards," he said.
Markets had expected that RBI would perhaps begin to sound out the need to withdraw liquidity. However, MPC’s resolution statement on 6 December doubled up on its commitment to keeping the liquidity surplus. But the minutes now show that MPC had reservations on liquidity but all members felt that the time to withdraw has not come. Nevertheless, Varma’s warnings give ample indication that RBI is worried about the plunge in short-term rates due to liquidity.
Even as surfeit liquidity is creating problems, the slack in the economy is helping keep a lid on inflationary pressures somewhat. Member Ashima Goyal has countered that the pressure of liquidity on inflation is less.
In essence, the minutes reveal a worried MPC silently preparing for a potential increase in inflation even though growth continues to trouble as well.
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