It only gets worse for RBI as inflationary pressures loom
As economic recovery gets more entrenched, a further rise in services inflation cannot be discounted
India’s inflation is a tough beast to tame. What better indicator than the recent increase in inflationary pressures despite the pandemic-induced recession. Headline retail inflation rose to 5.03% in February and the March print is expected to be no different. The old problem of sticky core inflation is back, and the rise in global commodity prices is only adding fuel to this fire.
Economists are already raising red flags over the retail inflation trajectory. In February, core inflation, which is inflation stripped of food and fuel, rose to almost 6%. Within core inflation, the pressure points are everywhere from transportation to healthcare.
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Even discretionary items such as recreation are showing a faster increase. Analysts at Nomura Financial Advisory and Securities (India) Pvt. Ltd point out that month-on-month momentum in core inflation is worrisome. “Overall, the takeaway from the February inflation data are growing signs that a combination of higher commodity prices and normalizing domestic demand are resulting in higher momentum in core inflation. Looking to March, the inflation dynamics appear adverse, not least due to adverse base effects," they said in a note.
Indeed, as economic recovery gets more entrenched, a further rise in services inflation cannot be discounted. Shubhada Rao of QuantEco Research points out that services inflation is still modest and this could change. “Additionally, services inflation, which has so far remained rather well behaved could also see a stronger comeback especially in H2FY22 amid vaccine-led revenge demand in select services such as tourism, air travel, hospitality among others," she wrote in a note.
But the problem of core inflation is not new and the Reserve Bank of India (RBI) has anticipated this. What should worry the central bank is what this core inflation reflects. Part of the rise in core inflation has also been the surge in fuel prices through transportation component. Here, a $10 per barrel rise in the Indian crude basket pushes up domestic fuel prices by at least ₹5, according to Rao.
A cut in duties on fuel could offset this and can result in 25-30 basis points moderation in inflation. That leaves other goods and services. The wholesale price index (WPI) inflation has surged 4.17% in February from just 2.03% in the previous month. WPI reflects the pricing power of producers and this shows India’s firms are able to charge more for their wares.
The upshot is that inflation is everywhere and this is a threat to a fledgling recovery. Already fuel inflation has begun to force Indians to cut on consumption. The central bank’s options are clear. The liquidity normalization that RBI began would now have to gather steam. An accommodative monetary policy stance woudn’t last for more than two quarters now. Nomura expects the central bank to begin normalization in first half of FY22 and to finally hike its repo rate in the fourth quarter.
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