A long battle against inflation

Containing inflation remains challenging

The retail inflation rate for August at 7 per cent surprised most analysts on the upside. Since the increase in prices has been fairly broad-based, it is likely the rate will remain elevated in the coming months. In August, for instance, prices of cereals went up by 9.57 per cent, while vegetable prices increased by over 13 per cent. Overall, the food price inflation rate was at 7.62 per cent. Even as core inflation continues to remain sticky, the pressure on food prices may continue, given the lower rainfall in some parts of the country. The government on its part imposed restrictions on rice exports last week to contain prices. Although estimates suggest that the impact of uneven rainfall on overall production would be manageable, it may still affect prices in the coming months.

The government has taken a number of measures over the past several months to contain inflationary pressures. It not only banned wheat exports as yields dropped because of the heat wave in several parts of the country, but also seems to have nudged the public sector oil marketing companies to not pass on the increase in international crude oil prices. The government is now reportedly contemplating providing Rs 20,000 crore to oil companies for absorbing the increase in international gas prices. While some of these measures may have helped contain inflation, they have also distorted the market with potentially longer-term implications. For instance, although international crude oil prices have come down by about 25 per cent over the past three months, it has not led to lower pump prices. It is now likely that the oil companies may first cut and cover their losses before passing on the benefit to consumers. This is an opaque process and affects consumer expectations.

The evolving macroeconomic conditions have made things somewhat more difficult for the Reserve Bank of India (RBI). The inflation rate has remained above the upper end of the tolerance band for eight consecutive months and, according to estimates, it may not come within the band over the next few months. Thus, the RBI first has to bring it below 6 per cent, and then aim to keep the rate closer to the 4 per cent target. It’s going to be a long battle. While the RBI has been tightening policy and financial conditions to contain inflation, economic growth may not turn out to be as strong as expected. The gross domestic product growth in the first quarter of the current fiscal year came at 13.5 per cent compared to the RBI’s forecast of 16.2 per cent.

Thus, given the projection for coming quarters, growth is likely to remain below the 7 per cent mark in the ongoing fiscal year. The index of industrial production growth, for example, moderated to 2.4 per cent in July. However, despite lower than expected growth, the RBI will need to focus on inflation. Analysts expect it to further increase the policy repo rate by 35-50 basis points later this month. Given the sustained price pressure, it would make sense for the Monetary Policy Committee to increase the policy rate by 50 basis points. The RBI is also trying to contain inflation by aggressively tackling rupee volatility in the foreign exchange market. Since the external conditions are unlikely to change significantly in the near term, not allowing the rupee to adjust will create distortions that are best avoided.