Home / Opinion / Views /  We will spend much of 2022 in a tussle with inflation

A few weeks after the Berlin Wall fell in 1989, marauding crowds in Dresden (part of former East Germany) forced a KGB agent stationed in the city to hightail it back home to Russia, which was also experiencing seismic economic and political upheavals. Economic hardships reportedly forced the former agent to moonlight as a taxi driver. He is today Russian President Vladimir Putin. Smarting from his country’s economic and political meltdown, he is now looking to restore its “former glory". Nobody knows what that exactly means or entails, but looking at the mobilization of Russian troops along Ukraine’s borders, or Moscow’s new-found conviviality with the Taliban, Putin’s geo-political ambitions present the world with significant uncertainties over the next 12 months.

The other big risk lies in the way the US-China dynamic will play out next year. US President Joe Biden’s “compete-collaborate-confront" China policy will acquire some form over the next 12 months. Intriguingly, China’s hand or state of play remains inscrutable. All these are bound to have some impact on India. As the end of this calendar year draws near, it might be instructive to list some risks that lie in wait for India next year. And, in the interest of sober-headed analysis, it’s best done before seasonal cheer clouds reality.

In the balance of risks that could come knocking on India’s doors in 2022, economic risks—both domestic and geo-economic—seem to top the list. And many of these risks seem to converge to a single point: inflationary pressures.

The post-pandemic inflation story has so far ebbed and flowed: Consumer prices rose initially as supply chains were fractured, then they moderated from December 2020 onwards as demand and supply somewhat matched, but spiralled up again April 2021 onwards with the onset of a deadlier second wave of covid infections. Long story short, India’s consumer price inflation rate has stayed consistently above the Reserve Bank of India’s (RBI) central target but within the broad comfort zone—above 4% but below 6%, except for the six-month period of June-November 2020.

Danger lurks in the wholesale price index (WPI), which reported a 14.23% year-on-year increase in November 2021. The WPI represents producer inflation, as opposed to consumer inflation. India’s year-on-year WPI rate has been in the double digits since April 2021. But, ominously, the gap between wholesale and consumer inflation has been widening (see chart), and the difference amounted to 9.32 percentage points during November. This reflects one simple fact: High WPI levels, representing increased input costs at the manufacturing level, have not yet been passed on to the consumer. Here lies the greatest risk of the coming months: Increased input costs could eventually be passed on, perhaps partially or fully, which would lead to elevated consumer price levels.

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Pressure on the price index will also come from abroad. Inflation concerns are forcing central banks in advanced economies to start retreating from their accommodative policies. The Bank of England has led the charge by hiking interest rates. The US Federal Reserve has also indicated that it will now terminate its bond-buying programme earlier than planned, apart from also increasing interest rates earlier than envisaged. These developments are already feeding through the global economic system and manifesting themselves in plunging Indian capital-market indices and a depreciating rupee vis-a-vis the US dollar.

A weaker rupee will have an added impact on the country’s inflation rate as import costs go up. India is a net importer of goods, especially of oil and oil products. The Energy Information Administration of the US has forecast that Brent crude prices will range between $71 and $73 from now till March 2022, and remain close to $70 for the rest of next year. The only way to reduce our oil import bill is to forcibly reduce consumption, but that is unlikely in the short term. Meanwhile, two other factors have the potential to nudge price indices upwards. One is recent increases in telecom-service tariffs. The second is the goods and services tax (GST) fitment committee’s proposal to increase GST rates across slabs, which, if it materializes, is likely to have an inflationary impact as well.

All eyes will be on RBI to see how it balances the need to restrain inflationary impulses with the task of fostering growth (which is still sputtering) and maintaining financial sector stability. RBI’s task is made more complex by the global divergence in recovery rates and actions by central banks. RBI has already indicated its intentions for the next few months: drain out liquidity slowly while soft-signalling higher interest rates through variable rate reverse repo auctions, rather than the usual benchmark rate changes, which would run the risk of disrupting our growth recovery. Lending rates at some banks and finance companies have already started inching up.

But RBI’s real test will be how it manages the souring loan books of these institutions. According to a 16 December note from economic forecasting firm Oxford Economics, “Legacy balance sheet stresses have not disappeared and may even worsen in the aftermath of the Covid crisis… The risks are especially pronounced for the more indebted medium and small enterprises and will continue to constrain private investment." When coupled with wavering capacity utilization, a resurgence of bad loans has the potential to dampen output and add fuel to inflationary impulses.

And we haven’t even begun discussing Omicron, which, hopefully, won’t be as disruptive as the Delta variant.

Rajrishi Singhal is a policy consultant, journalist and author.

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