By Swati Arora
Higher domestic inflationary pressure is likely to keep the Reserve Bank of India in a tough spot in FY2022. The RBI is likely to sway towards supporting growth and keeping its monetary stance accommodative. While rate cuts are off the table in FY2022, some amount of liquidity normalisation is likely going forward, especially if demand quickly rebounds over the coming months.
Inflation concerns have resurfaced yet again. And they are just not limited to India. With an increase in liquidity in the system and expansionary fiscal policies announced by the governments to curb the economic impact of the virus, inflation has moved up the ladder in most of the advanced and emerging economies.
In addition, the reopening of economies and supply constraints have weighed on the inflation reading. Inflation in the US rose to a 13-year high of 5.0% and to a 2-year high of 2.1% in the UK.
In the emerging economies, inflation rose to 6.02% in Russia in June 2021 and is hovering above 16% in Turkey. Well, that is one externality associated with expansionary monetary and fiscal policies.
Inflation spikes transitory or here to stay?
Most of the central bankers reckon that the spike in inflation readings is transitory and will wane over time once supply-side bottlenecks ease and pent-up demand normalise. In 2021, inflationary pressures are likely to stay however, are expected to cool off in 2022 with relief from some expected normalisation in commodity prices (including metal prices), liquidity normalisation, and supply-side pressures ease.
India’s CPI inflation has been on an upward trajectory since September 2019 for different reasons.
The domestic inflation story
On the domestic front, India’s CPI inflation has been on an upward trajectory since September 2019 for different reasons. In the October-December quarter of 2019, an uptick in inflation was largely driven by higher vegetables and protein prices, revision in telecom and medicine prices. In 2020, high food prices due to Covid led supply disruptions, higher gold prices, petroleum prices, and sticky core inflation weighed on the inflation heading.
Will this year be any different? Likely not. More risks than one for CPI inflation
On one hand, one can argue that in uncertain times, an individual with income uncertainty due to rising unemployment tends to spend less on discretionary items and buffer up savings which should ideally keep inflation in check. While on the other hand, pent-up demand (with the lifting of Covid related lockdowns across most cities), higher services inflation (even with a moderate recovery in demand), higher global inflation, and higher input and fuel prices are likely to impart upside pressure on inflation. At this juncture, the balance of risks is tilted towards a higher inflationary print this year as well, with inflation (average) likely to hover around the RBI’s upper threshold of 6.0% as compared to 6.2% in FY2021.
Health inflation becoming a concern
Most Indians pay for health expenses from their pocket as public sending remains low. Out of pocket health spending (as % of health expenditure) in India stands at ~63%. With higher health inflation, the burden on the households could aggravate. Health inflation has been on an upward trajectory since May-20 and has risen to 8.4% in June 2021, led by higher medicine and doctor’s consultation fee.
Global inflation to feed into domestic inflation
We have seen in the past how higher global food inflation has filtered into domestic food inflation especially for the products that India imports. There is a strong correlation between global edible oil and domestic oil inflation. Global oil prices rose by more than 100% per cent on an annualised basis in May 2021 while domestic oils and fats rose to an all-time high of 34.8 per cent in June 2021, reflecting an increase in international oil prices and as domestic production remained inadequate.
Global inflation is likely to remain elevated in the coming months due to pent-up demand and a rise in oil prices.
As highlighted before, global inflation is likely to remain elevated in the coming months due to pent-up demand (as economies recover and on account of expansionary fiscal policies) and a rise in oil prices. Higher global inflation could feed into domestic inflation via imported goods.
Increase in inflation to have a bearing on the household savings
Household financial savings moderated for the second consecutive quarter to 8.2% of GDP in Q3 from 10.4% in Q2. The rise in expenditure on discretionary items with the lifting of Covid lockdown could have weighed on households saving. Going forward, a persistent rise in inflation is likely to keep households savings in check. The fact that formal workers are digging into their EPF funds due to income uncertainty and an increase in emergency medical expenses, shows the rising burden on the households.
Since April 2020, 35 million formal workers have withdrawn a total of Rs 1.25 lakh crore from their PF accounts.
Since April 2020, 35 million formal workers have withdrawn a total of Rs 1.25 lakh crore from their PF accounts. Out of this, 7.2 million workers availed non-refundable Covid advance totalling Rs 18,500 crore. In FY19, the total claims settled stood at Rs 81,200 cr. to 160 lakh subscribers. A slowdown in households savings can, in turn, have an impact on the growth as higher saving provides capital for investment.
Some breather in terms of cut in excise duty
The Indian government has slashed import duty on edible oils (palm oil, refined oil, effective from 1st July 2021. Will this provide some relief to the end-users? Perhaps not much. Duties have not been cut on soya bean or sunflower oil, widely consumed by Indian families. Besides, if suppliers increase the prices, the benefit of duty cuts will be nullified.
Will the government reduce excise duties on petrol and diesel?
Fuel prices have both direct and second-round impacts on inflation. With petrol and diesel prices burgeoning, prices of essential commodities ranging from food prices to medicines and services are also likely to increase due to a rise in transportation costs. With crude oil prices expected to firm up further in the coming months supported by a pickup in inoculation drive and easing of travel restrictions (up by ~50% in CYTD 2021 are trading around $75-76 pb), petrol and diesel prices are likely to increase further.
A cut in excise duty on fuel could provide some breather. However, with additional fiscal burden stemming from vaccination drive, an extension of free food grains to low income households, additional fertiliser subsidy, a new health scheme announced and extension of Atamnirbhar Rojgar Yojana announced by the government, a cut in excise duty on fuels seems unlikely this year.
Higher domestic inflationary pressure is likely to keep the RBI in a tough spot in FY2022.
Higher domestic inflationary pressure is likely to keep the RBI in a tough spot in FY2022. The RBI is likely to sway towards supporting growth and keeping its monetary stance accommodative. While rate cuts are off the table in FY2022, some amount of liquidity normalisation is likely going forward, especially if demand quickly rebounds over the coming months.
(Swati Arora is an economist with HDFC Bank with around six years of experience in economic research with specialization in macro-economy, public policy and financial markets.)
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