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Home / Opinion / Columns /  Inflation wasn’t transitory even earlier and is likely to go up now

Starting in December 2019, Reserve Bank of India (RBI) Governor Shaktikanta Das has referred to inflation as being transitory multiple times. Since then to January 2022, our average monthly inflation as measured by India’s consumer price index (CPI), referred to as ‘retail inflation’, has been 5.9%. In the past one year, our average monthly retail inflation has been 5.3%.

As Das said recently: “Failure to meet the monetary policy objective is defined in terms of average headline CPI inflation remaining lower or higher than the 2% to 6% band for three consecutive quarters." While RBI has met its monetary policy objective so far, that doesn’t mean that inflation has been transitory. In fact, in the last year, average monthly wholesale inflation has been at 11.6%. This is now translating into inflation at the retail level as companies pass on higher costs of inputs that go into the making of products, to end consumers.

As Nielsen IQ India, a company which studies consumer behaviour, recently said: “Higher inflation levels during 2021 have led to… double digit price increases, resulting [in a] consumption slowdown in urban markets and consumption degrowth in rural markets." Degrowth is analyst-speak for contraction.

There has been a contraction in volume or unit numbers sold by fast moving consumer goods (FMCG) companies, which largely sell products of daily use. The volume contraction from October to December was 2.6%. Hence, as companies raise prices, end consumers buy less stuff than before.

Inflation will further accelerate with oil prices rising after Russia invaded Ukraine. As of 4 March, the Indian basket of crude oil was priced $111.6 per barrel. Oil prices are up on speculation that the US and EU are considering a ban on the export of Russian crude oil, of which Russia is the world’s second largest exporter.

The pressure of high oil prices is yet to be felt at the Indian retail level, as fuel prices have not moved since 4 November. With state elections done, prices are now expected to go up. Analysts at ICICI Securities estimate that just to break even, oil marketing companies, which sell auto fuel, need to immediately increase the price by 12.1 per litre.

Higher fuel prices will also push up prices in an indirect way by feeding into supply chains and in turn pushing up prices of other goods and services. Amul’s recent milk-price hike is a good example. As a Bloomberg report said: “Amul hiked milk prices… citing higher costs for energy, packaging, logistics and cattle feed."

Another factor that is likely to push up inflation is the dollar-rupee exchange rate. As of 8 March, $1 was worth about 77. It was 75 at the end of January. The rupee has come under pressure against the dollar because of foreign institutional investors (FIIs) selling stocks worth more than 91,000 crore on stock markets in 2022.

This is primarily because in crisis times, the world looks at the US dollar as a safe asset and money moves into it. Further, the rich world faces unprecedented levels of inflation. Hence, central banks of the rich world are expected to start raising interest rates. Jerome Powell, chairman of the US Federal Reserve, recently told the American Congress that the Fed plans to raise interest rates soon. Higher interest rates on offer in the US will lead to FIIs pulling more money out of India, putting further pressure on the rupee. Of course, RBI can intervene and sell dollars in order to steady this currency fall, but there is a limit to this because our central bank can’t create dollars out of thin air.

Like all central banks, RBI also faces a classic external-front trilemma. A central bank cannot have free international movement of capital, a fixed exchange rate and an independent monetary policy, all at the same time. It can only choose two of those three. Given that RBI will opt for free movement of capital and an independent monetary policy, it will have to let the rupee depreciate.

A weaker rupee will push up prices of imported products, including oil, coal, edible oil, fertilizers, metals and natural gas. This will feed into retail inflation further, including food inflation. The operation of field machinery in agriculture requires diesel. Further, natural gas is required to produce fertilizers and other agrochemicals.

Of course, the government could cushion some of this by decreasing the excise duty it charges on petrol and diesel, but that will only be of limited help if the war in Europe continues and possibly escalates.

To conclude, RBI has lately maintained that it cannot do much to control inflation because it is largely due to supply constraints on goods. Now, will it continue to offer this argument and keep running a low-interest rate monetary policy, especially at a time when other emerging world central banks have already raised interest rates and the Fed is expected to do so as well?

A depreciating rupee will further eat into the returns of foreign investors. This may lead them to sell even more Indian stocks, and the associated outflows of money would put further downward pressure on the rupee. Hence, RBI may finally be forced to raise interest rates, something which it has avoided doing over the last two years. That bit notwithstanding, inflation was never really transitory. It still isn’t.

Vivek Kaul is the author of ‘Bad Money’

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