At least expectations of inflation aren’t a cause
PremiumRising oil and other costs pose RBI a challenge, but it’s a relief that it does not really need to worry about wage hikes like central banks faced with tight labour markets in the rich world
As inflationary pressures trigger policy resets around the world, India may need to follow suit. On Thursday, when the Monetary Policy Committee (MPC) of the Reserve Bank of India (RBI) announces its latest review, inflation may well have taken centre-stage in its policy calculus. Consumer price inflation, at a five-month high of 5.6% in December, has been above RBI’s 4% medium-term target and uncomfortably close to its 6% upper tolerance limit. Should its assessment point to an impending breach, the MPC may have no option but to signal a clearly hardened stance, with RBI lifting the reverse repo rate at which it absorbs liquidity for alignment with its variable-rate repo actions. The rate at which it lends banks money could be upped next fiscal year. Whatever tools are used this week, a gradual reversal of covid-period easing needs to be made explicit.
Sure, even a slow tightening of credit could put the economy’s recovery at risk. But a loss of inflation control would do greater damage, not just to financial projections made in rupees, but also to RBI’s credentials as an inflation-targeter, a role that counts as a major economic reform. Wholesale prices have risen at double-digit rates lately and may soon exert themselves at the retail level, with a wide range of companies opting for mark-ups as input costs swell. Apart from covid-disrupted supply chains and high freight rates, a recent surge in the global prices of oil and other commodities has been a significant factor in darkening the world’s outlook. So too in India. While RBI tracks people’s inklings every two months as part of its Consumer Confidence Survey—around four-fifths have been expecting higher inflation a year ahead—such inflation expectations play a tiny role in policy formulation. Unlike in the US, where a tight labour market can combine with perceptions of lost price control to push costs up in a wage-push spiral, household forecasts are not a self-fulfilling threat in India. This is a relief for RBI.
Though high-skill sectors have seen talent scarcities and rising salaries, Indian labour abundance tends to broadly favour employers over employees to such an extent that wage bills are mostly irrelevant. While large businesses do compete for expertise in several fields, the effect on pay scales doesn’t impact general price forecasts. Instead, cost-push inflation in the country typically relates to material inputs. The rupee’s external value matters too, especially for price-inelastic essentials like oil that get dearer when our currency weakens. As 2022-23 rolls in, a potential reversal of weak consumer demand—likely if the budget’s growth spurs take effect—may cause supply shortfalls in a host of markets for products and services. Of course, given the remnants of uncertainty caused by the pandemic, actual outcomes are difficult to predict. What we can be sure of is that our structural supply constraints have eased considerably since 1991 (food remains an outlier), leaving domestic inflation mostly a monetary phenomenon. Before RBI’s formal adoption of inflation as a target in 2016, critics had argued that unclear links between price levels and labour trends (among other major variables) would hobble the accuracy of this new approach to price stability. It is to RBI’s credit that we haven’t seen any serious breach of its target band since. Let’s keep it that way. For the rupee’s internal value to stay on a slope that’s both gentle and predictable, however, RBI’s normalization of policy must gain pace.
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