Retail prices grew at 7.8% in April, the highest since the Narendra Modi-led National Democratic Alliance (NDA) government assumed power in May 2014, squeezing household budgets, potentially affecting consumer confidence, and setting the stage for more monetary action by the Reserve Bank of India’s Monetary Policy Committee (MPC) which raised the rate last week to combat spiking inflation. A rate hike will make loans, including consumer loans and mortgages, costlier.
The latest inflation numbers, driven by an increase in prices across categories, including food, will put further pressure on MPC to roll back the monetary easing which was announced after the Covid-19 pandemic dealt a body blow to the economy, and will increase the cost of loans for both companies and individuals.
The latest Index of Industrial Production (IIP) number, which measures factory output — it grew at just 1.9% in the month of March — suggests that the greenfield economy is still struggling to find a sustainable recovery, making RBI’s task that much more difficult.
Experts believe that this combination of tepid economic activity and high inflation poses serious challenges for the Indian economy going forward. What could complicate matters further is the fact that a lot of the price outlook going forward will depend on the geopolitical situation, something beyond the control of both fiscal and monetary policy in the country. With aggregate demand still low, inflation is being fuelled by supply side issues, including a sharp rise in commodity prices caused by the Russian invasion of Ukraine.
Retail inflation, as measured by the Consumer Price Index (CPI) grew at 7.79% in April as compared to last April. This is 36 basis points — one basis point is one hundredth of a percentage point — higher than the 7.43% projection made by a Bloomberg poll of economists. The April inflation number is significantly higher than the 6.95% reading in March. April is also the fourth consecutive month when inflation has been above the 6% mark, which is the upper limit of the tolerance band under the inflation targeting framework in India. The headline inflation number has been increasing continuously since October 2021, when it was 4.48%.
The latest inflation number is still significantly lower than the all-time high of 11.51% in the month of November 2013.
What will make the pain of inflation even worse is the fact that food prices are growing at an even faster rate. The food part of CPI basket grew at 8.38% in April, a sharp increase from the already high print of 7.68% in the month of March. Food items have a weight of 39% in the CPI basket, but the share of food spending is significantly higher for the poorer sections of the population.
To be sure, price pressures are quite broad based in the economy. This can be seen from the fact that apart from housing (3.47%) and paan, tobacco and intoxicants (2.7%) all broad subcategories of the CPI basket, saw an annual inflation of 7% or more in the month of April.
“This is an hour of unprecedented crisis as we are witnessing the twin effects of a geopolitical crisis and profit-led inflation on price levels,” said Himanshu, an associate professor of economics at Jawaharlal Nehru University. “While the traditional tools of monetary policy will not work very well, it is important that the government takes pro-active relief measures financed through income redistribution. Otherwise we will see demand destruction at the bottom of the economic pyramid in a big way, which will inflict further damage on not just immediate but also long term growth prospects.”
In an unscheduled meeting on May 4, RBI’s MPC announced a 40 basis point hike in the policy rate and also increased the Cash Reserve Ratio (which defines how much of their deposits banks need to keep with the central bank) by 50 basis points. The rate hike was the first in 45 months. MPC will meet once again in the first week of June and most analysts expect interest rates to be raised once again. The policy rate was 5.15% in February 2020.
“Rising inflation and external risks brought forward the rate-hike cycle of Reserve Bank of India (RBI). We expect RBI to raise repo rates by another 75-100 bps in the rest of this fiscal. This move cannot bring down food or fuel inflation, but can help check its generalisation by curbing the second-round effects”, a CRISIL research note said. Repo rate is the rate at which RBI lends to other banks.
What will add to worries on the economic front along with the latest inflation numbers is the tepid IIP growth in the month of March. At 1.9%, the March IIP numbers came out slightly higher than the February value of 1.5%. However, the pace of recovery is still slow. The manufacturing component of IIP grew just 0.9% in the month of March, while the consumer goods category continued its contraction streak which began in October 2021. While the annual growth in IIP in 2021-22 is impressive at 11.3%, this came on the base of an 8.4% contraction in 2020-21.
“If global inflation does not sufficiently decline despite aggressive monetary tightening sharply slowing growth, it points at the persistence of supply-demand imbalances that only coordinated actions of world leaders can resolve. Global economy, still in the process of reversing supply-side disruptions caused by the Covid-19 pandemic, would have been far more comfortably placed in the absence of the Russia-Ukraine conflict and the economic sanctions it has led to,” the Department of Economic Affairs, an arm of the Union finance ministry, said in its Monthly Economic Review released on Thursday.
“Accounting for the available high-frequency prices and today’s data, we are now currently tracking May CPI at around 6.8% y/y, which will continue to keep inflationary concerns intact in the RBI’s mind going into the June policy meeting, where we expect a 50bp hike in the policy rate,” Rahul Bajoria, MD & Chief India Economist, Barclays, said.