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The rise of the Consumer Price Index beyond RBI’s comfort zone of 2-6 per cent cannot be combated with monetary measures as it is a result of rising international crude prices and supply chain disruptions due to Covid-induced local lockdowns. So, the central bank is rightly pursuing growth by keeping interest rates low.
The rate of retail inflation, which is measured by the Consumer Price Index (CPI) in India has spiked to 6.3 per cent in May. This is a six-month high. The CPI, which measures prices that consumers pay at shopping counters, has gone beyond the Reserve Bank of India’s comfort zone of 4 per cent with a tolerance band of 2 per cent on either side for the first time in recent months.
Simultaneously, the Wholesale Price Index, which measures prices at the farm gate and factory gate, soared to a recent record high of 12.94 per cent in May
This has reopened the growth versus price control debate in India. Should the RBI shed its dovish approach and accommodative stance and increase interest rates?
The spike in prices is not a result of excess demand chasing goods. It is mainly due to the global increase in crude prices and the effect of cascading taxes on prices of fuel. The other reason is the disruption of supply chains as a result of lockdowns in many parts of India.
That might be self-defeating as the current spike in prices is not a result of excess demand chasing goods in short supply. The main cause of the price rise is the global increase in crude prices and the effect of cascading taxes inflating the retail prices of petrol and diesel across India. The other reason is the disruption of supply chains as a result of localised and state-wide lockdowns across many parts of India as a result of the second wave of the Covid-19 pandemic.
Therefore, the abnormal rise in the two inflation indices, though alarming at first sight, are not issues that can be moderated through monetary policy measures. These pressures are likely to ease as more states progressively begin the process of unlocking their economies as the second wave of the Covid-19 pandemic wanes.
At its last bi-monthly monetary policy meeting, the RBI has rightly maintained an accommodative stance as the Indian economy could be on the verge of a roaring post-lockdown comeback, as was witnessed in the last two quarters of 2020-21, on the back of pent-up demand and the gradual easing of supply curbs and the reopening of offices and factories.
The rise in the two inflation indices, though alarming at first sight, cannot be combatted through monetary policy measures. They are likely to ease as states progressively begin the process of unlocking their economies as the second wave of the Covid-19 pandemic wanes.
It is pertinent to note here that several high frequency indicators such as demand for steel and cement, generation of electricity, port cargo handling and railway freight traffic showed a downturn after states across India imposed full or partial lockdowns.
So, it is fair to expect that these will pick up pace as the unlock process gathers momentum – as is happening now.
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Increasing the cost of money, and, in the bargain, making every large purchase that consumers make more expensive, will arrest the nascent recovery being witnessed in diverse sectors such as automobiles, electronics, fast moving consumer goods and housing.
Any knee-jerk reaction by the Monetary Policy Committee (MPC) of RBI at this point will increase the cost of funds and impede the expected uptick in industrial production and domestic consumption. It will be relevant to mention here that in India, almost all housing stock, 80 per cent of automobiles and a disproportionate percentage of white goods and consumer durables are purchased with funding from banks and other lenders.
At a time when consumer confidence remains skittish. The RBI’s Current Situation Index (CSI) and the Future Expectation Index (FEI) fell to their respective all-time lows of 48.5 and 96.4 in the latest figures released on June 5.
Despite the havoc wrought by the second wave of the pandemic, leading agencies such as RBI, global ratings agency Fitch and several leading brokerage houses have said its impact will be less severe than that of the first wave.
With the monsoon rains this forecast to be in the normal range, rural demand, a critical but often ignored factor in the Indian economy, is likely to remain buoyant.
Increasing the cost of money, and, in the bargain, making every large purchase that consumers make more expensive, will arrest the nascent recovery being witnessed in diverse sectors such as automobiles, electronics, fast moving consumer goods and housing.
However, the trend of rising global commodity prices does pose a medium-term challenge for the RBI. With demand across the world forecast to rise, this trend may not be arrested anytime soon.
But for now, it may be best to wait and watch – and not tinker with interest rates at all.