As inflation rears its ugly head, RBI will find it hard to focus on growth2 min read . Updated: 03 Aug 2020, 10:15 PM IST
- For the monetary policy committee, the biggest headache is the return of inflation this time around
- Prices of most commodities have shown a rise despite a large part of demand being wiped out due to lockdown
The Reserve Bank of India’s (RBI) rate-setting committee will begin its three-day meeting on Tuesday and the conditions are treacherous.
FY21 is expected to be a recessionary year, but more worrying is the declining prospect of an early recovery.
Regional lockdowns and a stubborn infection curve of the coronavirus pandemic have meant that business activity would be seen in spurts rather than a steady rise.
Indeed, India’s manufacturing purchasing managers’ index (PMI) data for July shows that the recovery seen in June has stalled.
While growth remains a major concern, the biggest headache for the Monetary Policy Committee is the return of inflation.
Blame it on supply chain disruption, taxes by a fund-starved government and even ingenious ways through which service providers price in a pandemic cost. The prices of most commodities have shown a rise despite a large part of demand being wiped out due to the lockdown.
Analysts at Standard Chartered Bank note that 90% of the pressure on headline inflation in April came from core inflation.
“We raise our CPI inflation forecast for FY21 to 4.7% from 3.5%. This is mainly due to a likely rise in food and core CPI, which we see at 4.9% and 4.7%, respectively (versus 2.8% and 4.2% earlier)," said a research note by the bank.
The committee’s comfort zone is 4% inflation and clearly the readings would be higher. Also, food inflation has a big potential to lift household inflation expectations, which are mostly adaptive in nature. Ergo, the central bank will need to tiptoe carefully on its inflation narrative.
Most economists believe this return of inflation would tie the committee’s hands in voting for a rate cut again in this week’s deliberations.
“Inflation is going to be a problem. So, prudently, the RBI should pause now and wait to see how the price situation pans out," said an economist with a foreign bank, requesting anonymity.
But the RBI need not feel anxious about a recovery because it has done what it can. The central bank has already chopped its policy rate by 115 basis points in just six months. Market yields are way ahead with short-term treasury bill yields and even private sector commercial paper rates barely above the policy rate of 4%.
In short, the RBI already seems to have created a conducive interest rate environment for companies to borrow for usual business needs.
What companies now need is for demand to come back, and this could take a while. Indians are unlikely to boost their discretionary spending amid a pandemic. That said, the initial signs of a pickup in retail loan growth are encouraging.
Much of the recovery now depends on the infection curve and how the regional lockdowns influence this curve. And there, the RBI can do little.