Inflation outlook adverse, but economic contraction is over: RBI

The MPC now expects consumer price index-based inflation to average at 6.8% in the current quarter, and at 5.8% in January-March 2021

Continuing its pause on the policy rate in its December meeting, the Monetary Policy Committee (MPC) underlined that consumer inflation is on the higher side.
 
The MPC expects consumer price index-based (CPI) inflation to average at 6.8 per cent in the December quarter (Q3), and at 5.8 per cent in Q4 of financial year 2020-21 (FY21). This is substantially higher than its initial estimate of inflation falling in the 4.5-5-5 per cent range in the second half of FY21.
 
“The outlook for inflation has turned adverse relative to expectations in the last two months. The substantial wedge between wholesale and retail inflation points to supply side bottlenecks and large margins being charged to the consumer,” the MPC said.
 
RBI Governor Shaktikanta Das said three factors are fuelling consumer inflation: Supply chain disruptions, excessive margins, and indirect taxes.
 
The second factor is visible in the wide margin between consumer and wholesale inflation since the lockdown. Heavy excise duties on petrol and diesel are also adding to costs.
 
Not much is known about supply chain disruptions, beyond obvious factors like the restrictions and vagaries of the weather. The disruption could well be in the supply itself, rather than the supply chain. It could be labour shortages in some cases, and in others, many small and informal firms may have stalled activities, economists said.
 
Das said cost-push pressures continue to impinge on core inflation, which could remain sticky.
 
Experts have warned of a change in course soon if the situation persists. “RBI considers current high inflation levels to be mostly supply driven, but if core inflation levels continue to show a persistent upward trend and push inflation expectations upwards, markets should be prepared for a rather quick change in the current course, earlier than expected,” said Rajni Thakur, economist at RBL Bank.

 
Moderation in prices of perishable goods would provide transient relief, Das said. However, the MPC found inflation expectations of households have eased modestly in anticipation of seasonal moderation in food prices.
 
On growth, the MPC said it sees real GDP growing 0.1 per cent in Q3, followed by 0.7 per cent growth in Q4. But as the signs of recovery are not broad based, but dependent on policy support, inflation moderation will take time, the MPC said.
 
Further, injection of liquidity through the build-up of forex reserves, which has a tendency to become inflationary, is also being balanced through reverse repo operations, under which banks are parking close to Rs 7 trillion on most days. This is aiding the movement of inflation to uncontrollable levels.
 
The MPC pause was on expected lines, said experts.
 
“The concern that price pressures are spreading, and the strong defence of price stability indicate that the room for further rate cuts is negligible, but rates will remain low for a long period due to extended pauses,” said Aditi Nayar, principal economist at ICRA.
 
But the pause also raises some key concerns. “Businesses, especially small ones and those in the informal sector, will continue to face high borrowing interest rates on working capital,” Rumki Majumdar, economist at Deloitte India, wrote in a note.