The RBI had decided not to increase the repo rate in its policy announced on the 6th as it was confident that inflation was under control. The latest data for March shows that inflation has come at less than 6% at 5.7% which supports the decision.
In fact, the inflation numbers are going to trend downwards because of the base effect. In economics the term base effect is used to explain low or high growth number based on the last year’s number being biased. In this case, inflation numbers have been very high in April-June 2022 at above 7% in each of these months. This means that the inflation numbers for the coming months will be moving down which is in line with the RBI’s projections on inflation being 5.1% for the first quarter. Does this give satisfaction?
First we must remember that inflation at 5% still means that prices are going up and hence often it is a misconception to interpret falling inflation as falling prices. Prices are still going up, albeit at a lower rate is the meaning of inflation coming down to 5.7% in February from 6.4% in January. In fact for the year, inflation has averaged 6.7% on top of 5.5% in FY22. If one adds FY21 when it was 6.2%, it cumulatively means households are worse off by 18.4% in 3 years after covid started. This is serious especially when one compares the return on savings in the rudimentary bank deposit.
Second, inflation remains a concern in two areas in the food basket. These are cereals and milk. Last year there was a decline in wheat output due to adverse climatic conditions which have been replicated this year too. The government maintains that wheat production will not be affected while market sources say otherwise. Ultimately it will have to be seen if there is any supply deficiency as this can translate to higher prices once again. Last year the government was also not able to procure adequately through the Food Corporation of India as farmers chose to sell outside at higher prices.
Milk prices have been rising gradually every year and this time there have been three hikes which has caused high inflation of around 7.5% for the year. The price of milk unlike wheat never comes down even when shocks settle down. This was a case of fodder prices going up along with other inputs. Therefore higher prices are here to stay.
Third, there are two sources of concern when it comes to inflation – oil and monsoon. Crude oil prices apparently have not been affecting us. But this is due to the new pricing dynamics. The retail price of petrol in Mumbai is say Rs 106/litre and has been at this level for almost 10 months. This was during times when the crude oil price crossed $ 120/barrel as well as when it came to less than $ 80/barrel. This meant that there was protection when prices went up, but there was no relief when the price came down. The reason is simple. The burden is shared between the OMC and consumer most of the time as the government has not been willing to share the cost. (It has done so twice in the last 3 years when excise was lowered, but states have not followed suit).
Crude oil price risk remains as one is not sure as to how high it can go. Typically a price under $ 100/barrel may not lead to any change in retail price as this is a pre-elections year. Anything higher can invoke a price increase. Therefore this needs to be tracked closely. However, the government has been increasing the price of LPG quite frequently which is adding to inflationary pressures. Therefore, crude oil continues to be a stress point.
The other area of concern is the monsoon. There are conflicting reports on expectations of the monsoon. The IMD expects 96% of long term average which is normal while Skymet, a private agency, expects a shortfall with the level being 94% of average. This year it is expected that there will be an El Niño event which typically means sub-optimal monsoon. Past experience has been sketchy but in this situation would be critical as India’s growth story is premised on a good harvest leading to steady rural income and demand. The inflation potential too resides here.
Last, what is called core inflation, which is non-food and non-oil inflation has been sticky at around 6%. This is linked to products produced by companies which can be goods or services (health, education, recreation). All companies have been through a phase of rising input costs in the last 2 years but have only recently since September 2022 started passing them on through higher prices. This process is still on and indications are that this may have ended in March with some residual spillover in the first quarter of next year. This being the case, there is some potential inflation around the corner.
Hence, while the inflation situation at the institutional level appears to be under control, there are latent threats on both food and oil sides besides the cost-push forces. The RBI forecasts of 5.2% for the year look reasonable though there can be some upward risk. This also means that the basic target of 4% will not be achieved anytime soon.
Also from the point of view of the consumer, even another 5% over 18% in the last 3 years would mean cumulatively close to 25% in 4 years. This is at a time when incomes may not be rising at the same rate across the board. And for retired people who depend on deposits and other fixed income sources, this would be additional strain.
Madan Sabnavis is Chief Economist, Bank of Baroda, and author of ‘Lockdown or economic destruction?’ Views are personal
