Dusting Off the Inflation Cap

Context: With the rise in inflation due to supply disruptions amidst pandemic, inflation may need closer monitoring now than in the recent past.

Reasons for closer monitoring of inflation

• Real interest rates nearing negative territory:

• Real rates are now at zero and their positive or negative movement depends on the trajectory of inflation – (Real rates = nominal rates – inflation).

• Risks of shifting inflation expectations: Inflation expectation are an important driver of future inflation.

• Since the inflation rates have been falling now, expectations might also be subdued.

• Continuing supply side disruptions: 3 specific supply side disruptions include labour, logistics and finance of which finance led may last the longest.

• Labour disruption: Informal Sector (85% of the workforce) largely depending on cash and does not have enough savings to withstand large lockdowns.

• Logistics: Failure of viable firms may lead to large scale disruptions.

• Finance: 

• Risk averse banks fearing of bankruptcies and rising non-performing loans, 
• Have not passed repo rates to lending rated adequately.
• Weak credit growth.

Measures taken RBI

• Rate setting – repo rate has been cut by 115 bps
• Liquidity infusion – (Rs 6 trillion)
• Regulation – through extension of loan moratoriums