Dipak Kurmi
(He can be contacted at dipaknewslive@gmail.com)
After the discussion around the rise in inflation to a three-month high of 6.52% in January settled down, an old question resurfaced: Is the Reserve Bank of India (RBI) falling behind in its efforts to combat inflation? This question has arisen even as the fixed-income markets have already ruled out the possibility of rate hikes, and analysts have concluded that the RBI’s rate-hike cycle has come to an end. This viewpoint has been circulating despite the hawkish stance taken by the RBI in its last Monetary Policy Committee (MPC) meeting.
Before discussing the outlook of the Monetary Policy Committee (MPC), let us review what occurred with inflation. In 2022, even though inflation expectations rapidly increased for both consumers and businesses due to the Ukraine conflict, consumer inflation data reached its highest point in April, when the government introduced fiscal policies to protect consumers from higher prices. Furthermore, the downward trend in global commodity prices that began in September 2022 led to a significant decrease in imported and wholesale inflation in India. As a result, pressure on the public treasury has decreased, although the financial savings have yet to be completely passed on to consumers. The government must strengthen public finances to fund its welfare programs.
Currently, there is a discrepancy emerging between wholesale prices and consumer prices, which raises the question of whether inflation will rise or fall. It is important to distinguish between the price pressures faced by consumers and businesses at this stage.
To begin with, let us examine the business aspect. According to most inflation surveys conducted for businesses, including the one by the Indian Institute of Management-Ahmedabad, there has been a significant reduction in business inflation expectations, aided by decreasing input costs. In the Reserve Bank of India’s industrial outlook survey, the cost of raw materials is no longer as significant a hindrance as it was in the past few quarters. In the services outlook survey, selling prices have increased, in line with the data from the Purchasing Managers’ Index, and profit margins have expanded after shrinking for a few quarters.
Although disinflation in business costs may decrease the impulse of input cost pass-through and potentially benefit business profits, the situation for consumers is different.
The rises in certain food prices, such as cereals and milk, are expected to outweigh the declines in prices of vegetables, cooking oil, and eggs, at least in terms of the general perception of an increase in food prices, even though the reality is that the food price index has remained steady since August of last year. This situation has been compounded by the depletion of food stocks, and the impact of higher global food prices is being felt as exports and farmers benefit from it.
Although consumers may find some solace in the fact that retail prices do not have the same force pushing them higher, unlike the situation in early 2022, they are also unlikely to benefit significantly from the reduction in goods inflation, as producers maintain their pricing advantage.
This does not necessarily have to be a negative factor for the economy. Prior to the budget, there was a small but lively debate regarding the appropriate level of nominal Gross Domestic Product (GDP) growth for India. We have always believed that this question does not solely revolve around the deflator or real GDP growth, but rather involves a division between these two factors. Given the cost structure of the economy, increases or decreases in profits can shape growth in the real economy, making the process more endogenous than before. In other words, if businesses are making more profits, and certain consumers, such as those in the agriculture or services sectors, have pricing power, this should encourage consumption for businesses and the agriculture-driven rural sector, as they do not operate in a vacuum.
This implies that if there is a degree of pricing power in the economy, it is likely a reflection of strong growth momentum. However, this momentum may weaken in the coming months as the combination of high-interest rates, tight liquidity in the banking sector, and a loss of global GDP momentum causes growth to decline somewhat. As a result, the fading of pricing power is likely to become more apparent. Therefore, inflation should decrease alongside growth, rather than the two metrics operating as separate outcomes with no real connection between them.
What implications does this have for monetary policy? The higher-than-expected January inflation, along with a more hawkish tone from members of the Monetary Policy Committee (MPC), tilts the risk balance for the MPC going forward.
Therefore, we believe that the probability of a rate hike in April has increased, given the higher inflation in January and the more hawkish stance of some members of the Monetary Policy Committee. It is expected that the voting pattern will be divided between 3-3 or 4-2. However, if there is a greater transmission of lower fuel prices through policy measures, this could alter the situation.
If economic activity continues to be strong and there is significant pricing power, the RBI can afford to take its time in implementing rate hikes. However, this does not mean that the central bank will keep delaying action, as doing so could lead to a situation where the momentum of the economy is lost, resulting in a hard landing.