Inflation is proving to be the Achilles Heel in the Indian economy’s recovery from the pandemic and subsequent global disruptions. After softening for three consecutive months, it spiked again in January. The Reserve Bank of India has been playing the part of an inflation targeting central bank over the last few months, raising interest rates in an attempt to rein in inflation. However the fight to bring inflation down is clearly far from over. The latest inflation data also raises the question if the RBI doing enough.
The inflation targeting framework mandates the RBI to achieve a CPI (consumer price index) inflation target of 4 percent. During the pandemic period of March 2020 to September 2021, CPI inflation averaged 5.9 percent. This was higher than the point target of 4 percent but still within the inflation targeting band of 2-6 percent. Since then, however, the inflation outlook has been worsening.
In 2022, CPI inflation was above the upper threshold of the RBI’s targeting band for 10 consecutive months which meant that the target was not achieved for three quarters in a row. Inflation began softening towards the later part of the year. By December 2022, CPI inflation was down to 5.7 percent. This led many to believe that the inflation peak had passed, and that inflation was on its way to the official target.
This optimism was misplaced. Underlying inflationary pressures still persist. The softening of inflation in November and December 2022 was largely driven by a steep fall in vegetable prices. Excluding vegetables, CPI inflation was infact more than 7 percent. The misplaced optimism has now become evident. The January 2023 CPI inflation came out to be 6.5 percent, once again crossing the upper threshold of the RBI’s inflation targeting band.
The risks to inflation outlook that have continued unabated over the last few months have contributed to the latest spike in inflation as well.
First, with food accounting for 46 percent of the overall CPI basket, a rise in food inflation from roughly 4 percent in December 2022 to almost 6 percent in January 2023 has played an important role in overall inflation going up. Within food, one component that has proved rather stubborn is cereal inflation. Between May and December 2022, year on year cereal inflation nearly doubled from 5 percent to 14 percent. In January 2023, this increased to 16 percent. Within cereals, inflation in wheat has been steadily going up. Between May and December 2022, wheat inflation increased from 9 percent to 22 percent. It increased even further to 25 percent in January 2023.
The steep rise in wheat prices reflects shortages. Data from the Food Corporation of India shows that stocks in government warehouses declined from 33 million tonnes in January 2022 to 17 million tonnes in January 2023. The government has recently approved a release of 3 million tonnes in the open market. However this is insufficient to restore market supplies. Given that the next harvest will not be ready till April, and government stocks in February are further down to 15 million tonnes, this source of inflationary pressure is likely to persist for a while.
Secondly, core (non-food, non-fuel) inflation in January came out to be 6.2 percent. This is consistent with the unyielding core inflation of 6 percent for nearly three years now. A persistently high core inflation implies that price pressures have become entrenched in the system. Part of this can be explained by the continued pass-through of high input prices to final goods prices. Interestingly this is happening even when WPI (wholesale price index) inflation, which reflects input prices, has come down from a high of 16 percent in May 2022 to less than 5 percent in January 2023. This implies that with margins getting squeezed and profitability suffering, firms are spreading out the pass-through over a longer time period. This makes the core inflation trajectory uncertain.
Finally, external factors have a role to play as well. Inflation in developed countries continues to be high (6.4 percent in US; 8.5 percent in EU; 10.5 percent in UK). India is importing some of this elevated inflation through international trade in goods and services. Moreover, with China gradually opening up its economy after nearly three years of Zero-Covid restrictions, commodity prices are likely to go up which could exert renewed pressures on India’s inflation.
What have the policymakers been doing to address the inflationary concerns?
The government has done its bit by announcing a conservative Union Budget for 2023-24. It has accorded primacy to much needed fiscal consolidation, and has refrained from announcing populist measures which could have arguably fuelled demand, and hence inflation.
The RBI has been doing its job as well. It increased the policy repo rate from a pandemic-low of 4 percent to 6.5 percent in a span of 10 months. It has also adopted a hawkish tone as was evident from its latest monetary policy statement. Unlike last year when despite rising inflation, the monetary policy statements did not contain any forward guidance, in its February 2023 statement, the RBI emphasised the importance to "remain alert on inflation", thereby hinting that the monetary tightening cycle is not over yet. Is there anything else that the central bank can do?
Having missed the inflation target for three consecutive quarters in 2022, the RBI had to submit a report to the government describing a plan of action which would help bring inflation down. The law does not require either the RBI or the government to disclose the contents of this report publicly. However, given that inflation is proving to be difficult to rein in, and that the 4 percent target is not likely to be achieved next year either, releasing the report to especially highlight the remedial actions that the RBI plans to undertake might help stabilise inflation expectations, and facilitate the central bank’s own endeavour to fight inflation.
A credible glide path to bring inflation down to the target level is of critical importance particularly now with the national elections around the corner.
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