Uptick in inflation driven by supply shocks, should ease over the year: RBI

The tapering of the second wave, coupled with an aggressive vaccination push, has brightened near-term prospects for the Indian economy, the central bank said in its monthly bulletin for July

India's central bank on Thursday said that a pick-up in inflation rate was purely driven by supply shocks and sector-specific demand-supply mismatches caused by the coronavirus pandemic.

The Reserve Bank of India (RBI), in its monthly bulletin for July, said these factors should ease over the year as supply side measures take effect.

Further, it said that the tapering of the second coronavirus wave, coupled with an aggressive vaccination push, has brightened near-term prospects for the Indian economy.

The RBI said there had been a rise in mobility indicators and attendance at workplaces, as well as jumps in advance tax payments, power consumption, digital transactions and other indicators in the month of June, all of which it considered forerunners to a revival in business and consumer confidence.

The central bank warned that a solid increase in aggregate demand is yet to take shape even though several high frequency indicators of activity are recovering.

"On the supply side, agricultural conditions are turning buoyant with the revival in the monsoon, but the recovery of manufacturing and services sectors has been interrupted by the second wave," RBI said.

Although India's second wave is ebbing, the infection rate is rising again, worrying authorities who are concerned that pilgrimages and tourism could prove to be "superspreader" events.

Citing the data collected from banks, the RBI said that the transmission of policy repo rate changes has improved substantially over last two years. The share of outstanding loans linked to external benchmark in total floating rate loans has increased from as low as 2.4 per cent during September 2019 to 28.5 per cent by the end of 2020-21. 

"The adoption of external benchmark-based pricing of loans has strengthened market impulses for a quicker adjustment in deposit rates. Further, a combination of surplus liquidity conditions amidst weak credit demand conditions has enabled banks to lower their deposit rates. The lowering of deposit rates has resulted in the decline in cost of funds for SCBs, prompting them to reduce their MCLRs, and in turn their lending rates."

India's retail inflation rose less than expected in June but stayed above the central bank's target band of 2%-6% for a second straight month.

The RBI said there were specific demand-supply mismatches, for instance in the case of protein-rich food items, edible oils and pulses, which were being addressed by specific supply-side measures.

"But more needs to be done. Elevated international commodity prices, especially of crude, are also imparting cost-push pressures. These factors should ease over the year as supply-side measures take effect," the RBI said.

"Furthermore, a solid increase in aggregate demand is yet to take shape. Even with a 9.5% GDP growth in 2020/21, there will be substantial slack in the economy and demand pressures may take some more time to become evident."