Moneycontrol PRO

Why inflation will remain a worry for some months

Prices of food, fuel, and commodities are rising. What gives?

October 22, 2021 / 01:26 PM IST
Inflation projection for the third quarter was lowered to 4.3 percent from the August estimate of 5.3 percent. [Representative image]

Inflation projection for the third quarter was lowered to 4.3 percent from the August estimate of 5.3 percent. [Representative image]


Onions and tomatoes have become more expensive and so have petrol and diesel since the monetary policy committee of the Reserve Bank of India met earlier this month. Prices of other vegetables have also moved up after heavy rains in parts of the country damaged standing crops. These increases are bound to further upset household budgets and show up in the consumer price index reading for October.

Cooking gas, or liquefied petroleum gas, have also been rising with every adjustment at the beginning of every month. It will inch close to the Rs 1,000 mark per 14.2 kg cylinder if global crude oil prices continue to rise. International prices of almost every commodity are elevated and trending upwards as supplies remain tight.

A mixed bag

The Monetary Policy Committee (MPC) of the Reserve Bank of India had cautioned that elevated global crude oil and other commodity prices, combined with acute shortage of key industrial components and high logistics costs, were adding to input cost pressures. However, it expected food prices, including those of vegetables, to stay muted due to record production and supply-side measures taken by the government. As a warning, it said unseasonal rains and adverse weather-related events were upside risks to vegetable prices.

Its overall assessment was that the moderating CPI headline momentum combined with favourable base effects in the coming months would substantially soften inflation in the near term. And, so the MPC lowered its projections for the consumer price index (CPI) based inflation for the fiscal year 2021-22 by 40 basis points to 5.3 percent from its August forecast of 5.7 percent.

Close

One basis point is a hundredth of a percentage point.

Inflation projection for the third quarter was lowered to 4.3 percent from the August estimate of 5.3 percent. However, it cautioned that the evolving inflation situation needed a close watch.

While the RBI expects the CPI inflation to stay within its tolerance band, economists are concerned about the risks.

In its commentary on the September reading of the CPI, QuantEco Research noted that the inflation trajectory was expected to move up in the fourth quarter of 2021-22, with readings testing RBI’s upper threshold of inflation band of 6 percent. The RBI had projected the fourth quarter CPI at 5.8 percent. QuantEco estimates the average inflation for 2021-22 at 5.6 percent, higher than the 5.3 percent projected by the RBI.

Blame it on crude shocks

Rising prices of crude is a chief worry. On Thursday, October 21, Brent crude climbed to a three-year high above $86 a barrel before retreating to $84-85. Brent crude has jumped about 9 percent in October from $78.13 a barrel on September 30.

India’s oil basket, which is a blend of the Brent crude and an average of Dubai and Oman rates, rose to about $84 a barrel from $76.71. Rising crude prices have pushed up prices of petrol above Rs 106 a litre in Delhi and diesel above Rs 95 by October 21, an increase of more than Rs 5 a litre this month.

Crude prices look set to rise higher as the Organisation of Petroleum Exporting Countries and allies (OPEC+) are unwilling to increase supplies. Goldman Sachs had forecast that oil prices could rise to $90 a barrel before the end of the year, as demand recovery from the Delta impact was faster than anticipated. Demand will remain elevated in the winter months, given the crisis in the energy market due to shortages of coal and natural gas.

The constant upward revision in the fuel prices will increase inflationary pressures. Only fiscal measures - a reduction of taxes on petroleum products - can moderate that pressure if global prices continue to rise. However, the Union and state governments are dependent on revenues from petroleum products.

Still, robust growth in collections of direct taxes and the GST may create room for a cut in taxes on petroleum products. India Ratings & Research chief economist Devendra Kumar Pant expects cut petroleum taxes by the Union government towards the end of the fourth quarter.

Another worry is the disruptions caused by the coal shortages. It can disrupt the domestic supply chains, cautions Dr BR Ambedkar School of Economics vice-chancellor NR Bhanumurthy. The shortage can have some impact on growth and inflation, as it has come at a juncture when factories were normalising operations after the localised shutdowns to contain the spread of the Delta variant and the global value chains were getting mended.

A CRISIL Research note on Thursday said Bihar, Maharashtra, Telangana, Tamil Nadu, Uttar Pradesh and Gujarat were structurally at higher risk of being impacted as these states have either a high dependence on coal or high short-term purchases. Maharashtra, Tamil Nadu, Gujarat and Uttar Pradesh have a large presence of industry and so supply chains may suffer.

Yet, it found that disruption in power supply had a limited impact on production in key clusters of 10 sectors ahead of the festival season. However, cement manufacturers in southern India and aluminium producers were badly affected. Small ceramic units and sponge iron units that depend on imported coal were facing pricing and availability issues.

What about food?

The recent spike in food prices, considered transitory, is expected to cool by the end of the festival season. However, prices of edible oil and pulses will remain a cause of concern.

An analysis by India Ratings and Research on Wednesday estimated that edible oil inflation will remain in double digits in the near term, given that about 60 percent of domestic demand is met from imports, chiefly by palm oil from Malaysia. Prices of palm oil in the Malaysian markets had jumped by about Rs 2,700-3050 a tonne as soon as India cut basic customs duties on the cooking medium to zero. This price increase will nullify any benefit that the Indian consumers were to get from the duty cut.

The second-round effects of elevated petroleum prices is also a worry. All sections of the population will suffer the impact of higher freight costs. That apart, shortages of labour and inputs too can prove inflationary in the coming months. More increases in prices of manufactured goods are on the anvil, as companies pass on some part of their increased costs to consumers in a phased manner.

For the moment, demand continues to be weak and price rises have hurt recovery in consumption. The divergence in the rise of the wholesale price index and the consumer price index illustrates that manufacturers are unable to pass on higher input costs, Dr Pant said.

The shortfall in semiconductor chips has been adding to inflationary pressures around the world. These chips are used in everything from watches and mobile phones to cars and control how any digital product functions. Breakdown in the logistics chains, involving shortages of ships and containers, too compounded scarcity of parts and raw materials and added to inflationary pressures across the world.

Over the next few months, RBI’s actions on inflation will be closely watched. For now, it is committed to supporting growth. However, the accommodative stance can begin to stoke inflation as demand picks up when mobility improves.

Dr Bhanumurty expects the RBI to move towards balancing growth and inflation. The RBI may choose to act after assessing the impact of the US Federal Reserve tapering bond purchases beginning in November.

If India experiences large capital outflows, some part of excess liquidity in the system will get drained. That makes the task of the Indian central bank easier.
Tina Edwin is a senior financial journalist based in New Delhi.
first published: Oct 22, 2021 01:26 pm

stay updated

Get Daily News on your Browser
Sections
ISO 27001 - BSI Assurance Mark