The latest data release for November 2022 shows that inflation is now within the RBI’s target range. This is undoubtedly good news. However, some major issues persist. Inflation remains much too high. And there is no clarity yet on how the central bank plans to bring it down to the target level.
Headline CPI (consumer price index) inflation came out to be 5.9 percent in November, down from 6.8 percent in October. This is the lowest inflation since December 2021. At the same time, global commodity prices have been falling, softening inflationary pressures. But that is pretty much where the good news ends. There remain at least five major concerns.
First, while it is true that inflation has slipped below the upper threshold of the RBI’s inflation targeting band, it is important to remember that 6 percent is not the RBI’s target. The RBI is legally mandated to aim for 4 percent inflation. This implies that there is still some way to go before CPI inflation reaches its target level.
Secondly, the decline in headline inflation did not reflect any fundamental change, but a steep fall in the price of vegetables. If one excludes vegetables, CPI inflation would infact have increased, to 7.2 percent.
Third, measures of underlying inflation indicate that price pressures remain stubbornly strong. Core (i.e., non-food, non-fuel) CPI inflation continues to be around 6 percent—the same level that it has been at for nearly three years now. This signifies that high inflation is deeply embedded in the system.
Why is core inflation so persistent, despite the easing of commodity price pressures? Most likely, because the economy is locked into a wage-price spiral. As the economy has opened up after two years of pandemic-induced restrictions, firms have had to pay higher wages to workers to bring them back, to compensate them for the price increases (for example, in fuel and transport prices) that occurred while they were away. Also, the depreciation of the rupee would have made it costlier for firms to import inputs. In both cases, firms seem to be passing these increases in costs on to the consumers in the form of higher prices.
Fourth, global inflation is still quite high. While inflation in the US has receded to 7.7 percent in October from 8.2 percent in September, inflation in the UK is 11 percent and rising, while that in the European Union has increased to 11.5 percent. As a result, India is importing high global inflation. This problem could intensify, if the rupee depreciates further, as advanced country central banks continue to tighten monetary conditions by raising interest rates.
Finally, cereal inflation remains exceptionally high, at 13 percent. It is difficult to understand why this is happening, since the government has been augmenting supplies by providing grains under its free food scheme (PM Garib Kalyan Anna Yojana) to all families holding a ration card. One possibility could be that traders are worried that the government’s buffer stocks are running low and that the winter harvest might prove disappointing.
Adding up all these factors makes it clear that it is way too early to declare victory on inflation. So, what is the strategy to bring inflation down?
It is true that the RBI has been consistently raising the policy repo rate since May 2022. The repo rate has gone up from 4 percent to 6.25 percent. The RBI has also been withdrawing surplus liquidity from the system to restrain the money supply. The Monetary Policy Committee (MPC) also seems more focused on inflation now compared to 2021-22. These are all steps in the right direction. But to break the persistence of the core inflation and bring inflation down to the target level of 4 percent, more effort might be required.
The RBI has predicted inflation to fall to 5.4 percent in the second quarter of 2023-24. But it has not yet indicated when it expects inflation to reach 4 percent—or what it plans to do to ensure that this target is achieved in a reasonable timeframe. Does it think that the current level of interest rate—which is only marginally higher than the underlying inflation rate—is sufficient to deliver the target in the next one year or so, implying that the RBI will continue to soften the pace of rate hikes or even end the tightening cycle soon? Or will further and steeper rate increases be necessary to ensure that monetary policy exerts sufficient downward pressure on inflation? It may help to provide some clarity on these issues.
Once the sanctity of a rule-based system is ignored for a while, it becomes more difficult to restore the credibility of that system. In India, a glaring example of this is the Fiscal Responsibility and Budget Management (FRBM) Act. After persistent deviations from the fiscal target for years, this institution has now ceased to be relevant and we may have normalised a high level of fiscal deficit. Inflation targeting should not suffer the same fate.
It is reassuring that the RBI has recently said that it has an “Arjuna’s eye” on inflation. It should now follow up by spelling out a strategy to ensure that Arjuna’s arrow hits its target.
No comments:
Post a Comment