On expected lines, India's retail inflation breached the upper tolerance band of the Reserve Bank of India (RBI) in February.
Inflation based on the Consumer Price Index (CPI), also known as retail inflation, rose to 6.07 percent in February from 6.01 percent in January, data released by the statistics ministry on March 14 showed.
Retail inflation hit its fastest pace in eight months in February owing to higher prices of food and manufactured goods. Besides, the Wholesale Price Index (WPI)-based inflation jumped to 13.11 percent in February from 12.96 percent in the previous month, data released by the commerce ministry on March 14 showed.
RBI is mandated to keep the inflation rate within the range of 2-6 percent until March 2026. In 2001, the central government and the RBI had agreed to keep the inflation target of 2-6 percent for the next five years. Section 45-ZA of the RBI Act, 1934 requires that the central government shall, in consultation with the RBI, determine the inflation target in terms of CPI, once in every five years.
What's the brouhaha about?
Let's talk about what's the relationship between growth and inflation in simple terms. Well, an economy needs to grow. And how does it achieve this? In two ways, one, by producing and consuming more than the past year. Second, by charging more for the same products. In real world, it is the combination of both as demand and prices are correlated. If demand goes up, then prices of those products, too, rise.
With that simplistic lesson out of the way, back to the main topic: relationship between growth and inflation.
Let's say you want to buy 5 kg of Product A which today costs ₹10. Next month, the same quantity costs ₹12. This ₹2 increase is inflation. Now, if you do not have ₹12, you will end up buying less quantity of Product A.
When you buy less quantity of the product you need, the economy as a whole either stagnates or contracts.
This is why inflation and growth of an economy are intertwined and RBI needs all the tools in its armour to ensure that the country continues to grow while keeping inflation in check.
Inflation woes
While the retail inflation has already been above RBI's tolerance band for the last two months, it is expected to remain at elevated levels thanks to the ongoing Russia-Ukraine war which has pushed crude oil and commodity prices higher. This will test RBI's patience while keeping the interest rates low and maintaining an accommodative policy stance.
However, as the central bank has been reiterating, it does not want to damage the nascent economic growth which is yet to recover fully from the Covid-induced shock. The recent Index of Industrial Production (IIP) numbers have shown the economic recovery is yet to pick a healthy pace.
IIP edged up to 1.31 percent in January, the second-lowest reported growth so far this financial year. In December, the country's industrial activity had slumped to a 10-month low at 0.7 percent.
Meanwhile, Morgan Stanley has slashed India's economic growth forecast by 50 basis points to 7.9 percent for the financial year 2022-23. Furthermore, the US investment bank and financial services company raised the country's retail inflation estimate to 6 percent.
What will RBI do?
RBI may continue to support growth and keep the rates intact in the next policy meet in April and use other available tools to manage inflation, experts and brokerages believe.
Brokerage firm Motilal Oswal Financial Services expects the RBI to prioritize growth in its April 2022 monetary policy meet as growth is still a bigger concern currently rather than inflation.
"We still expect the RBI to prioritize growth in its April monetary policy meet as we believe growth is still a bigger concern currently rather than inflation. We expect inflation in the range of 5.2-5.4 percent year-on-year in FY22," Motilal Oswal said.
"Given the increasing uncertainties, we expect a cautious stance in the upcoming April MPC meeting, with the RBI upwardly revising its muted inflation trajectory. However, with most of the recent build-up of price pressures being supply-led and MPC’s commitment for ensuring durable growth, we expect a status quo on stance and rates in April," brokerage firm Kotak Securities said in a report.
"We retain our 50 bps repo rate hike expectations in FY2023, but the timing will remain a function of evolving growth-inflation risks," Kotak said.
Brokerage firm Anand Rathi Share and Stock Brokers highlighted that in the recent past, the inflation build-up in India has stemmed primarily from global factors, such as high commodity prices, especially of crude and edible oil.
This, however, is changing. There has been some abatement of global commodity price pressures, excluding crude oil. With retail prices of petroleum products unchanged since November 2021, fuel and transport inflation rates abated, the brokerage added. These have been more than compensated by selective pass-throughs of cost rises in certain sectors and the unfavourable base effect for food products. The food price index, though, was flat after a fall in the two months prior.
Anand Rathi does not find the inflation outlook not alarming.
"The depressed base of the last 12 months and expected hikes in minimum support prices (MSP) of agricultural products (to support rural incomes) are likely to result in rising food prices. We expect core inflation to fall. Barring a continuation of high global crude oil prices and a full pass-through to domestic retail prices, average inflation for the next 12 months is likely to be around 5-5.5 percent," said Anand Rathi.
In its last monetary policy meeting in February, RBI had retained the inflation projection for 2021-22 at 5.3 percent, with the fourth quarter inflation at 5.7 percent.
Supply-chain disruptions due to the ongoing war in Europe and economic sanctions, the outlook for inflation remains uncertain.
"The government can, for now, limit the pass-through of high oil prices. Yet, this might turn out to be challenging if the situation persists or the rise continues. We expect the RBI to follow global cues and start raising policy rates, but moderately," Anand Rathi said.
Brokerage firm Nirmal Bang expects the RBI to shift to a ‘neutral’ stance in Q1FY23 (April or June) and also sees the possibility of a repo rate hike in June 2022. However, the brokerage firm is not factoring in rate hikes of more than 50bps in FY23 as growth concerns also persist.
