On The Other Hand
Inflation is likely to persist as a big economic problem in 2023
Retail inflation as measured by the consumer price index (CPI) came in at 5
Retail inflation as measured by the consumer price index (CPI) came in at 5.9% for November. Despite this being the lowest rate in 11 months, India’s troubles on the inflation front may not be over as yet. There are multiple reasons for the same.
First, November’s fall in inflation was primarily on account of a fall in prices of seasonal vegetables as well as oil and fats. Vegetables have a weightage of a little over 6% in the CPI and their prices fell 8.1%, whereas oil and fats have weightage of around 3.6% and their prices fell 0.6%. If we leave out the items under these headings, the rate of inflation in November was 7.3%.
Second, the base effect was at work with the index number for last November being on the higher side. This benefit will not be available in the months to come and is likely to push up inflation again.
Third, core inflation continues to remain high. It was at 6.5% in November and has been higher than 6% in eight of the last nine months. Further, it has been higher than 5% since June 2020.
Core inflation is the inflation of items that remain after excluding the food group, fuel-and-light group and petrol, diesel and other fuels for vehicles. The idea here is to look at the inflation that the Reserve Bank of India (RBI) has some ability to control, given that it has little control over food and fuel prices. Items used to calculate core inflation form around 52% of the overall CPI.
High core inflation can possibly be explained by the fact that high inflation expectations have set into the economy. Median inflation expectations one-year head have been higher than 10% since May 2020. In November, the figure stood at 10.8%, having fallen from 11% in September, but still high nonetheless.
People believe that inflation is here to stay, and hence have been demanding higher wages for the work that they do. The salaries and wages of more than 4,500 listed companies tracked by the Centre for Monitoring Indian Economy grew by 13.2% during July to September compared to the same period in 2021. They have been growing at a double- digit pace for the last six quarters. This gives us some indication of why core inflation is very high.
Fourth, for the one-year period ended 2 December, total bank loans have grown at a very fast pace of 17.5%. Of course, some of it is because of the base effect. Nonetheless, loans of all kinds have been growing rapidly. Retail lending of banks grew by more than 20% in October, the highest since the covid pandemic began. Lending to services businesses grew by 22.5%. Further, lending to micro and small industries and medium industries grew by 20.5% and 31%, respectively.
If lending continues to grow at this pace, then the chances of inflation falling are low. Higher retail lending will create private consumption demand, leading to more money chasing goods and services, and hence, higher prices. Higher lending to industry and services will create more jobs and feed into wage inflation in the process.
Now monetary policy takes time to seep into the economy. Up until now, that clearly hasn’t happened, despite lending rates on fresh rupee loans of banks going up from an average of 7.5% in April, before RBI started raising rates, to 8.7% in October. As interest rates have gone up, lending growth has picked up as well. The lending growth needs to slow down for inflation to come down to RBI’s target of 4%.
Hence, the question that arises is whether RBI should wait and watch, or continue to raise rates. The answer is not an easy one, given that if the central bank stops raising rates too soon, it may end up letting inflation run for a longer time. On the flip side, if RBI overdoes this, it will end up slowing down growth much more than it possibly estimates. Nonetheless, some slowing down of growth is inevitable if the objective is to control inflation.
Fifth, inflation in rich-world economies continues to be high. In November, retail inflation in the US and the Euro area were recorded at 7.1% and 10.1%, respectively. This, along with a weak rupee, will feed into higher imported inflation in India.
Sixth, the benefit of falling oil prices hasn’t been passed on to the Indian end consumer in the form of lower petrol and diesel prices. In Mumbai, the price of petrol and diesel has remained fixed at ₹106.31 per litre and ₹94.27 per litre, respectively, since mid-July. In July, the price of the Indian basket of crude oil had averaged $105.5 per barrel. In December, it averaged $77.8 per barrel. This approach to fuel pricing is not good news for inflation.
The latest round of a survey of professional forecasters on macroeconomic indicators that is regularly carried out by RBI expects inflation to moderate to 5.2% in 2023-24. Given that most of these forecasters are corporate economists, they have a tendency to underestimate inflation and then revise their forecasts as higher price levels become obvious. Take the case of 2022-23. Initially, the median forecast was for inflation of 4.7%. This has since been revised to 6.7%. This happened in previous years as well.
What all these factors essentially tell us is that we haven’t seen the last of inflation and it will continue to remain high well into 2023.
Vivek Kaul is the author of ‘Bad Money’
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First Published:20 Dec 2022, 10:33 PM IST
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