10 mins read . 21 Aug 2023
Just a couple of months back, everything looked hunky dory on the inflation front. India’s consumer inflation (CPI) for May 2023 had fallen to 4.25% and was just 25 bps short of the target of the RBI at 4%. During the same month, the US had reported consumer inflation at 4%, but it was a full 200 bps away from its inflation target of 2%. It may be recollected that in the last 3 policies in April, June and August, the RBI had opted to maintain status quo on repo rates.
The last repo rate hike by the RBI was in February when it had hiked the rates to 6.50%. Since then, it has stayed at that level. However, the situation at a policy level has bene very different in the US. Despite inflation coming down steadily in the US, the Fed continue to remain hawkish and barring a break in June, it has persisted with rate hikes. However, the last 2 months may leave the RBI with some food for thought.
The food price syndrome on Indian inflation was visible in the month of June itself. The CPI inflation in India jumped from 4.25% for May 2023 to 4.81% in June 2023. But that was just the start. A combination of delayed monsoons, followed by scattered deluges, resulted in prices of vegetables, cereals and pulses shooting through the roof. For July 2023, vegetables inflation shot to above 37% and the result was that the headline CPI inflation spiked from 4.81% in June 2023 to 7.44% in July 2023. That may sound unnerving and it actually is.
Now the India inflation is a full 344 bps away from its 4% target and food inflation is up at 11.55%, with vegetables, milk, cereals, and pulses doing most of the damage. During this period, the US consumer inflation fell further to 3% in June 2023 and moderately increased to 3.2% in July 2023. The result is that US inflation is now just 120 bps away from target. Before we delve into the implications for RBI policy, let us quickly look at the inflation story for July 2023.
To understand the consumer inflation in India in the proper perspective, there are 3 distinct inflation numbers that one must look at. There is the headline inflation, which is the overall inflation for the month. Then there is the food inflation, which has been most vulnerable in India and also has a weight of nearly 50% in the CPI inflation basket. Finally, there is core inflation, which is the residual inflation left after volatile items like food and fuel inflation are eliminated. Core inflation is structural in nature and can be sticky for long periods. Here is a month-wise analysis of the 3 pillars of India inflation.
Food Inflation (%)
Core Inflation (%)
Headline Inflation (%)
Data Source: MOSPI & Ministry of Finance Estimates
The latest spike in headline inflation to 7.44% takes very closer to the April 2022 peak of 7.79%. In short, nearly 1 year of effort at reducing inflation has almost come to nought. Of course, on an optimistic note, one can argue that this is more of a cyclical phase due to erratic monsoons. However, it cannot be denied that a lot of the inflation efforts of the past one year have been neutralized by this one spike.
The success of monetary policy will largely predicate on keeping the headline inflation as close to the 4% mark, or trending towards the 4% mark. That does not seem to be happening. One must not forget that the base effect is still helping fuel inflation, but even Brent Crude has spiked to $87/bbl. So, the pressure on inflation is now coming from multiple fronts. That brings us to the million dollar question. Was the RBI too optimistic in calling off rate hikes in February? Let us explore that question in greater detail.
It would be naïve to believe that the policymakers can afford to be smug about this spike in food inflation in July. Within the Monetary Policy Committee (MPC) the 3 RBI nominees had always veered towards more hawkishness. They are likely to have more of a say now. The latest spike in inflation will certainly change the equations of the RBI with respect to future repo rate trajectory.
At the time of the August policy statement, the markets were already pencilling in a 50% probability of a 25 bps rate hike by October. Now, the RBI may not have much of a choice but to hike rates. The only question whether the rate hike will wait till October or whether the RBI would want to front end the rate hike earlier than that. Now it looks like rate hikes are more a question of when, rather than whether.
Higher inflation was already a given, and even the Reuters estimates had pegged the inflation at above 6% for July and August. It is just that inflation has been more ferocious than expected. RBI has to not only manage inflation, but also the inflation expectations. The inflation expectations can be best managed by tweaking the monetary stance of the RBI.
The central bank may be impelled to shift to a more positively hawkish stance on monetary policy, either in October or even before that. With rate cuts off the table and rate hikes looking almost imminent, RBI may look to tweak the stance towards giving a more hawkish message. Food inflation has strong consumption externalities. The last thing the RBI would want is the spike in inflation to hamper the growth engine!