Inflation And Its Discontent

Context: So far, RBI has not responded to high inflation. Recent trends will persuade it to do so.

Recent trends in inflation: Until April this year, only Wholesale Inflation (WPI) was on the rise, led by fuel and commodity prices. But now, even retail inflation (CPI) picked up, printing at 6.3%.

• CPI inflation crossed the RBI’s upper limit of 6% after five months.

Implication of rising inflation:

• Hurts lenders: It is pertinent to note that with the repo rate at 4 per cent, the real rate (adjusted for inflation) has been negative for over a year.
  • Rising inflation reduces returns on fixed income instruments, including bank deposits, which ac- count for over 50% of households’ financial savings.
  • This has already induced a shift to riskier asset classes such as equities, which has ramifications for overall financial stability.
• Benefits borrowers: The government, one of the biggest borrowers, stands to benefit as high inflation will lower the national debt load in relation to the size of the economy.
  • The Union budget 2021-22 assumed a 14.4% growth in nominal GDP. However, actual growth is set to exceed this and could well be over 16% as per our estimates.
  • Viewed from a debt dynamics perspective, as the gap between growth and interest rates rises, the debt/GDP ratio falls.
• Reduces purchasing powers and hit private consumption: With incomes under stress, the impact on consumption can get magnified.
  • What is important to note in the present context is that inflation is likely to hit private consumption in rural areas more than in urban areas.
  • Lower food inflation (5%), coupled with higher non-food inflation (7.1%) in May, means reduced purchasing power for farmers.
  • Moreover, this year MGNREGA support is budgeted at a lower level, further reducing rural consumption.
• Raised input costs: Inflation trends, specifically input prices (reflected better by WPI), matter for corporate performance as well.
  • While producers seem to be bearing a part of the burden of rising input costs, for now, these could get passed on in greater measure to consumers once demand recovers.

Conclusion: Given the need for monetary policy to stay accommodative, it might be time to consider other supply-side interventions such as cuts in excise rates on petroleum products to soften the inflation blow.