India’s Inflation Outlook Isn’t As Benign As It May Seem

Context: Inflationary risks amid India’s COVID crisis are hard to assess but they must not be underestimated.

Recent Inflation Trends: 

• Headline Inflation at 6.09% - has breached the upper tolerance limit of the Reserve Bank of India (RBI).
• Majorly due to high food inflation: especially meat and fish at 16.22% and pulses at 16.68%.
• Inflation Paradox: While in comparison to the previous year, inflation did cross 6% mark, but during the period between Jan-June 2020 the overall headline inflation was just 0.93%

Multiple Explanatory Variables of Inflation and threats due to them.

• Falling Output:  Falling output in Emerging Market Economies (EMEs) is associated with an increase in the upside risks of inflation

• Tight Financial Conditions: may have both an accentuating and mitigating effect on inflation.

• Inflation gets exacerbated if credit-constrained firms increase their markups to protect cash flows.
• It may get attenuated if depressed financial conditions affect aggregate demand by lowering investments and hence consumption.

• Exchange Rate Volatility: Effect of exchange rate volatility is six times more pronounced in EMEs than in advanced economies (AEs).

• The Indian rupee had depreciated 6% by July since the beginning of the year, and this was significantly greater than most other Asian currencies.

• Global Oil Prices: while currently low, may witness a reversal in trend as the global economy starts moving towards recovery.

• Expanding Fiscal Deficit: would generate inflationary pressures.

• Risk-Averse Banking: Bank credit is likely to be constrained during fiscal 2020-21 as banks continue to be risk-averse, despite RBI and government measures to ease credit availability.

• Higher requirements of Statutory Liquidity Ratio have also impacted credit growth.

• Supply Chain Disruptions: 

• For E.g. In the agricultural sector, the lack of a well-developed supply chain, including warehousing facilities, to store and carry produce to markets during COVID may have been responsible for the slump in vegetable and egg prices.
• Steep fall in prices due to falling consumption and lack of availability of labour.