Rising retail inflation, a big headache for govt, RBI and you4 min read . Updated: 13 Mar 2021, 05:40 PM IST
- Retail inflation has quickened because of higher fuel prices and might turn out to be a big headache for everyone
During February, retail inflation, as measured by the consumer price index, touched a three-month high of 5%. Inflation during a month is the rate of price rise in comparison to the same month in the previous year. Retail inflation had stood at 4.1% in January. A major reason behind accelerating inflation has been the rise in petrol and diesel prices for vehicles, which rose by 20.6% and 22.5%, respectively. Petrol and diesel prices have been rising on account of higher oil price. The price of the Indian basket of crude oil stood at $67.4 per barrel as of 11 March, a little more than double the average price for March 2020, which was at $33.4 per barrel. India imports the bulk of the oil that it consumes.
The import dependency during 2020-21 has been at 84%. Also, the central excise duty collected by the government on petrol and diesel sold has gone up during the course of this financial year, and now stands at ₹32.90 per litre in case of petrol and ₹31.83 per litre in case of diesel, respectively. This increase in petrol and diesel prices has added to the overall increase in prices. In fact, core inflation, which excludes food and fuel inflation, for the month of February stood at 6%. This is the highest since June 2018, when core inflation stood at 6.1% (see chart below).
Also, this inflation is the second-highest in the last five years. It needs to be clarified here that the core index includes the petrol and diesel prices for vehicles. These items are a part of the transport index and not the fuel index, as is commonly believed. If we leave out the petrol and diesel prices for vehicles and other fuels for vehicles, along with the food items and fuel and light items, inflation stood at 5.5% in February, as it had in December and January, as well. What this tells us is that inflation has become sticky. Higher prices for petrol and diesel increase the cost of moving things from where they are produced to where they are consumed, and hence, over a period of time have an impact on prices of everything else, including food.
Food prices during February rose 3.9%. They had gone up by around 2% in January. Other than vegetables and foodgrains, the prices of pretty much everything else went up. The price of oil and fats went up by 20.8% during the month, egg, fish and meat by 11.3%, fruits by 6.3% and pulses by 12.5%. Other than impacting the quality of daily life of a common man, especially during such tough times where chances of an increment in a job or higher earning in a small business are low, high inflation has other repercussions as well. It makes things difficult for the Reserve Bank of India (RBI), which wants to maintain lower interest rates in order to ensure that people borrow and consume more, and companies borrow and expand.
At the same time, it wants to ensure that the government of India, which has plans to borrow a huge amount of money next year, can do that at a lower interest rate. But with core inflation being at its second-highest level in the last five years, the bond market is clearly not happy and is demanding a higher return from government bonds. The yield or the return on the 10-year government bond crossed 6.27% on 10 March. This, despite the RBI trying to control the yield at 6%. The yield on a bond is the return an investor earns by buying a bond on a certain date and at a certain price and holding on to it until maturity. This means that the government of India has to pay a higher return for borrowing money. If the government has to pay more and given that lending to the government is deemed to be the safest form of lending, the interest rates on all other kinds of lending should also go up in the time to come.
To cut a long story short, this makes the situation much more difficult for the RBI, which is trying to run what it calls an accommodative monetary policy, where money continues to be available at low-interest rates. Of course, the RBI can continue running an accommodative monetary policy by printing and pumping more money into the financial system in order to ensure that there is enough money going around, and thus, interest rates continue to remain low. But this has its own set of repercussions. Higher inflation also pulls down real economic growth. This is something that the government needs to take into account and cut down on excise duty on petrol and diesel. It has the option of continuing with higher excise duty and earning more from this tax, but in the process, it will also slow down the economy. And this will mean a lower collection of all other taxes.
Vivek Kaul is the author of Bad Money
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