Next up in the inflation battle

• In the global fight against high inflation, India’s story stands out because both monetary and fiscal policies were deployed early.
  
  
• India’s inflation problem is also domestically driven in that a large part of the recent rise in the CPI print is because of surging food prices, which account for ~40% of the inflation basket.
  
  
• CRISIL expects CPI inflation to average 6.8% this fiscal, versus 5.5% last fiscal.
  
  
• Expect the next monetary policy review in December to announce a 25-bps hike at least.

In the global fight against high inflation, India’s story stands out because both monetary and fiscal policies were deployed early.

That’s unlike systemically important global central banks, which have been quite the lone agents fighting for price stability in their remits. Slowly, however, the fiscal policy tool is being brought to bear, and such coordinated approaches would continue till inflation is tamed unequivocally.

The current inflation problem is largely supply-side driven — exogenous for many economies — so controlling it has been a fiendish challenge.

The pressures first began to rise with the post-pandemic global economic recovery that drove up prices of oil and commodities. This spilled over to fuel and parts of core inflation (transport and communications-related), which together form ~60% of India’s Consumer Price Index (CPI)-based inflation.

The Russia-Ukraine conflict aggravated matters by creating shortages in commodities, including energy. Prices of some commodities have moderated since, but their cost of import has stayed high because of a sharp depreciation of the rupee against the dollar.

But India’s inflation problem is also domestically driven in that a large part of the recent rise in the CPI print is because of surging food prices, which account for ~40% of the inflation basket.

Weather-related disturbances — the heat wave in April and May, delayed arrival followed by a belated withdrawal of southwest monsoon in some agriculturally important geographies — have hurt production and lifted prices of wheat and rice.

All that, and elevated prices of pesticides, animal feed, diesel and freight have meant the pressure on food prices has stayed high. So much so, food inflation is contributing ~45% to the rise in CPI inflation print.

There is little the Reserve Bank of India (RBI) can do to mitigate the rise in food and fuel inflation. While it aims to keep CPI inflation in the 2-6% band, the gauge has stayed well above this range for nearly nine months — despite its Monetary Policy Committee (MPC) raising the repo rate by 190 basis points (bps) between April and October.

To be sure, the hikes focus on taming inflation expectations to cut the second-round impact from the demand-side.


However, the hikes are unlikely to lower inflation immediately for two reasons. One, most of the inflationary pressure continues to be from the supply side, where interest rates have no direct impact. Two, interest rate transmission works with a lag of around eight to nine months.

It can thus be said that India’s fiscal policy measures are cushioning price pressure more, which sets it apart from other major economies. These include import duty reduction in edible oils, excise duty cuts on petrol and diesel, ban on wheat exports, duties on rice and steel exports, and purchase of cheaper Russian oil.

Another seminal fiscal countermeasure has been the PM Garib Kalyan Ann Yojana, or the food security welfare scheme. This has helped ease some pain at the bottom of the pyramid through allocation of 1,122 lakh metric tonnes of foodgrains to 80 crore beneficiaries over 28 months.

Interestingly, in this period, inflation in foodgrains (mainly rice and wheat) rose an average 6% (peaking at 7% in April) compared with 4% in the fiscal before Covid-19 struck.

To be sure, some pressures on food inflation will moderate as the kharif harvest hits the market. Also, for now, global food prices are softer so there could be some positive rub-off. But uncertainty on the food supplies will remain as long as Russia and Ukraine remain in conflict.

But prices of rabi crops like wheat and tur/arhar, which will be harvested next April, could remain under pressure. Similarly, fuel inflation could stay stickily high for longer as the weaker rupee adds to the impact of elevated global energy prices.

Then there is core inflation — comprising 54% of the CPI basket — which is already high at 6%.

As the ongoing economic recovery broad-bases and pricing power returns, manufacturers will start passing on higher input prices, which will crank up this print.

Consequently, CRISIL expects CPI inflation to average 6.8% this fiscal, versus 5.5% last fiscal. The first half average was 7.2%, so that number will likely descend in the second half, assuming no shocks.

Yet, it will continue to stay above the RBI’s upper tolerance band.

Ergo, expect the next monetary policy review in December to announce a 25-bps hike at least.

Given the myriad moving parts, it’s an unenviable job for central banks.


Dipti Deshpande is Principal Economist, CRISIL Ltd. Views are personal