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Managing Macro | Continuing low inflation is not guaranteed

Aside from food inflation, there are other structural issues that can affect inflation outcomes in near to medium term.

May 14, 2019 / 10:14 AM IST
Representative image

Representative image

Retail inflation for April came at 2.92 percent. As expected, food inflation picked up and was at 1.1 percent, compared to 0.3 percent in the previous month. Most economists expect a continued rise in food inflation. To be sure, softer food prices kept inflation at lower in recent years. A research note by economists at RBI, for instance, argued that an unexpected decline in food prices affected the central bank’s inflation projections.

However, food prices are now recovering. A report in The Indian Express on Monday showed that prices of items such as maize, jowar and bajra have gone up significantly compared to the last year. Additionally, prices of vegetables have also risen and milk is likely to get dearer. A meaningful recovery in food prices would affect RBI’s inflation projections. Though core inflation has moderated, it is still above the 4 percent mark. It would be interesting to see how the rate-setting committee reacts to the pick-up in food inflation.

However, aside from food inflation, there are other structural issues that can affect inflation outcomes in near to medium term. A recent note by three World Bank economists, Jongrim Ha, M. Ayhan Kose, Franziska Ohnsorge, underlined risks to low inflation in emerging economies. They note that reasons for the decline in inflation in the developing world are associated with “widespread adoption of effective and transparent monetary, exchange rate, and fiscal policy frameworks, as well as globalisation.”  Therefore, a reversal could affect inflation outcomes.

The note highlighted three important risks to low inflation which are also valid for India.

First, protectionism is rising globally and can affect trade. Data shows that more open economies tend to have lower inflation. A higher share of imports in production and consumption, among other things, creates pressure on producers to become more efficient. On the other hand, higher tariffs and other trade restrictions allow domestic producers to increase prices. A recent study showed that higher tariffs in the US lifted average manufacturing inflation by one percentage point. The result is unlikely to be very different in other countries. Further, there would be efficiency loss if the global value chain weakens. India would do well to avoid trade restrictions.


Second, a higher level of debt could affect the commitment to a strong fiscal framework in emerging economies. This is where India has real problems. While there has been some consolidation in recent years, the budget deficit remains uncomfortably high. It has been reported that the Union government missed the revenue target by Rs 1 lakh crore in the last fiscal. There would be continued pressure on government finances in the near term as leading political parties have committed to increasing expenditure. Indian policymakers need to rethink the way government finances are managed. Aside from being a risk to inflation, continued higher fiscal deficit can endanger financial stability.

Third, it is important to maintain the credibility of the central bank. Inflationary expectations are well anchored when the central bank is credible. India has done well to adopt the inflation targeting framework and there are initial signs of success. However, the recent spat between the government and the RBI on the issue of reserves, among other things, should have been avoided. Such incidents can potentially undermine the credibility of the central bank and affect its ability to manage inflation outcomes.

Low and stable inflation is necessary to maintain financial stability and higher growth. Therefore, it is important that policymakers don’t lose sight of both cyclical and structural risks to inflation.
Rajesh Kumar
first published: May 14, 2019 10:11 am

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