Inflation concerns

Renewed surge has increased risks

The consumer price index-based inflation rate for July has surprised most analysts. At a
15-month high of 7.44 per cent, it was about one percentage point above the consensus market
estimate. The surge in the inflation rate was driven by prices of food items, primarily vegetables.
While the overall food inflation rate came at 11.51 per cent, vegetable prices mapped by the
index went up by a whopping 37.34 per cent. Cereal prices too went up 13.04 per cent.
Although the surge was largely driven by food prices, analysts now expect the inflation rate to
remain elevated, and significantly above the upper end of the Reserve Bank of India’s (RBI’s)
tolerance band, even for August. Food prices, driven largely by seasonal factors, are expected
to start moderating in the October-December quarter.

The Monetary Policy Committee (MPC) of the RBI last week decided to keep the policy repo
rate unchanged at 6.5 per cent. Although the committee expected the inflation rate to increase,
it decided to see it through, with the expectation that it would come down as the seasonal
impact weakens over time. It was also of the view that a cumulative increase of 250 basis points
was still working through the system. However, it did revise upwards its inflation projection for
the ongoing financial year from 5.1 per cent to 5.4 per cent. If the inflation rate continues to
surprise on the upside, the central bank would have to once again revise its projection in the
next meeting. Since it’s the future path of inflation that matters more for an inflation-targeting
central bank, it would be interesting to see how the MPC expects inflation to behave in the next
financial year. In the last meeting, it projected the rate to be 5.2 per cent in the first quarter of
2024-25.

One possibility is that the relatively high base of this year would lead to a lower headline
number next year. But the MPC would need to be vigilant because the price momentum could
last longer, making it more broad-based. It’s worth noting that cereals are also witnessing a
double-digit rate of inflation. Given the uneven distribution of rain, a significant impact on food
production could push up prices with risks of inflation getting generalised. The government in
this context has taken pre-emptive measures by putting restrictions on export and stockholding
for various food items. Even though such measures are not in the long-term interests of the
farm sector, they could help contain prices in the immediate near term.

For the MPC, it would be comforting that the core inflation rate has moderated and, given the
global economic outlook, commodity prices, in general, are expected to remain contained,
though global food prices are showing signs of stiffness. Geopolitics continues to remain a risk
in this context. The situation nonetheless demands careful monitoring. If inflation projections
remain considerably above 4 per cent, it would become necessary for the MPC to reassess
whether the present level of the policy rate will be sufficient to attain the inflation target on a
durable basis. Would a material delay in attaining the target affect inflation expectations?
Meanwhile, financial markets will also need to reassess their assumptions of a rate cut — it
looks unlikely at least till the first half of next financial year. (566 words)