Rising Inflation - One of the biggest worries for the Indian economy

It is crucial to note that inflationary pressures are rising globally as well as back home. The latest reading of the US consumer price index came in at 8.5% - 40 year high in March 2022.

Rising Inflation - One of the biggest worries for the Indian economy

In a surprise move, the Reserve Bank of India (RBI) decided to raise the repo rate (interest rate) by 40 basis points to 4.40% on May 4, 2022 to combat rising inflation which is above RBI’s tolerance limit of 6%. This was the first-rate hike since August 2018 and also an off-cycle Monetary Policy Committee (MPC) meeting to reassess the evolving inflation-growth dynamics in the country. RBI Governor Shaktikanta Das said that the MPC expects inflation to rule at elevated levels, warranting resolute and calibrated steps to anchor inflation expectations and contain second round effects. Although sudden rate hike and quantum of it comes as a surprise to all as market anticipated rate hike probably in the next policy meet of June 2022.  It is crucial to note that inflationary pressures are rising globally as well as back home. The latest reading of the US consumer price index came in at 8.5% - 40 year high in March 2022. The inflation scenario back home as follows:

India’s retail inflation measured by the Consumer Price Index (CPI) rose to 17-month high of 6.95% in March 2022 compared to 6.07% in February 2022 and 5.52% in March 2021. (See chart) The rural and urban inflation has spiked to 7.66% and 6.12%, respectively in March 2022 compared to 4.61% and 6.52% in March 2021.  Food prices which account for nearly half the inflation basket surged to 7.68% in March 2022 compared to 5.85% in February 2022 and 4.87% in March 2021 while the inflation in the fuel and light category rose at a slower pace of 7.5% in March (compared to 8.7% in February). The wholesale price index (WPI) inflation too accelerated to 14.55% in March 2022 from 13.11% in February 2022 to rising crude oil and metal prices. 

Source: MOSPI

Factors contributing to the massive increase in inflation in the recent times:

  • Sharp jump in the global crude oil prices and other commodities due to disruption in the global supply chain in the wake of the Russia-Ukraine war is one of the biggest factors pushing inflation higher. Nearly 85% of the India’s crude oil requirement has to be met through imports. The Russia-Ukraine conflict has caused massive blow to edible oil supplies, leading to increase in its prices.
  • Another major contributor driving the food inflation higher is the unfavourable base effect. The inflation for vegetables, oil and fats, meat and fish has been double digit off late. The base effect compares the price levels in the current month to the price levels in the same month year ago. In event of the low inflation in the corresponding period of the previous year, even a smaller rise in the price index will arithmetically give a high rate of inflation now and vice versa.
  • Increase in inflation across all categories resulted in the core inflation breaching the 6% level. According to RBI, core inflation pressures remain elevated reflecting pass-through from higher crude oil and non-oil commodity prices, high fuel and other taxes post-COVID and increased operating costs.
  • The covid-19 induced economic slowdown in last two years have amplified supply bottlenecks and other shortages causing sharp increase in the price levels of several commodities.
  • As manufactures are dealing with rising input cost in terms of rising fuel, metals, chemical and other raw material cost they are have now started passing on higher prices to consumers in form of the higher output costs. Many auto, FMCG, telecom and other firms have announced price hikes.

Impact of higher inflation on different segments of economy

The surge in inflation is not just detrimental to economic growth but also impacts everyone. Rising inflation is definitely going to be additional burden on the households particularly lower income groups whose income levels have got impacted severely during the pandemic. For those who have parked their money in the traditional bank fixed deposits and other fixed income avenues the real returns are negative given the spike in inflation. Indian corporates too are raising concerns about higher inflation as they are experiencing profit squeeze due to higher input cost and supply chain strains. The worries about rising inflation have been one of the factors causing equity market volatility in the recent times.  

The way forward

Amid the backdrop of the rising inflationary pressures and weak global cues, monetary policy tightening was highly anticipated sooner or later. While the latest RBI move comes as a big surprise for all it clearly shows RBI’s strong commitment to financial stability by ensuring inflation is under control while supporting growth. Lastly, the current situation of rising price levels and rate hike calls for planning of the monthly budget and investment decisions more wisely.