After staying above the Reserve Bank of India’s (RBI) targeted range for over three quarters, inflation measured by the consumer price index (CPI) softened to 5.88 percent in November 2022, to be within the central bank’s range. Similarly, the wholesale price index (WPI) inflation, which stayed in double-digit for a long time, came down to 5.85 percent.
The drop in headline inflation was seen across commodities although there was a marginal jump in fuel group inflation in November. Among the commodities, food group inflation saw a sharp decline – from 7.01 percent in October to 4.67 percent in November.
However, there are estimates that suggest that core inflation is still at 6 percent, thus showing some stickiness. This was not a surprise as RBI researchers estimated that nearly 43 percent of CPI has a sticky price index while 57 percent display flexible price behaviour. Of greater concern is what could be the inflation trajectory for the next couple of quarters. For this, one needs to understand the reason for the surge in inflation in the last three quarters and the policy measures that have helped in reining in a further surge.
The fact that the MPC was surprised by inflation breaching 6 percent threshold only suggests a limited role for domestic factors and a larger contribution from global inflation and its pass-through. Added to this, the war as well as the normalisation of contact-intensive activities since the middle of the year appear to have only accentuated the price pressures.
Now that global demand and prices are cooling. it is expected that India’s inflation could also be below 6 percent. To understand the extent of decline in global inflation one may look at the International Monetary Fund’s (IMF) global price of food index estimates, which has reverted back to the pre-war levels. The index, which increased from 139.89 in January 2022, peaked at 161.7 in April. Since then, it has declined and is currently at 134.8, below the pre-war levels, thus suggesting the impact of the US Federal Reserve (Fed) tightening.
The Black Sea Grain Initiative, which helped ease supply chain disruptions from Ukraine, also helped in reducing prices, especially of cereals.
A recent study by IMF suggests that a one percent hike in the Fed rate could reduce global food inflation by 13 percent with a lag of a quarter. It means the impact of Fed tightening on global food prices is still not complete. As we expect more hikes, it only suggests that global food prices could be subdued for longer periods than expected.
This trend is visible even in the crude oil prices that peaked at over $123 a barrel and are currently hovering around $90. In sum, global factors that have led to a surge in domestic inflation since the beginning of the year are subdued and have reached pre-war levels. This should augur well for India’s inflation in the medium term.
But what are the domestic factors that contributed to the inflation surge as well as its reversal? As I have been arguing for some time, unlike the advanced countries (AEs) that went for a large fiscal stimulus, India followed a pragmatic policy that balanced reviving both demand and supply with a focus on capital expenditure. The fiscal stimulus in AEs led to a surge in aggregate demand while supply constraints were building up, and, in turn, led inflation to rise to levels last seen four decades ago.
Further, India had also ensured better fiscal-monetary policy coordination to mitigate shocks that emanated due to the pandemic and the war. Although customs duties were hiked, the impact of the war on domestic fuel prices was just the opposite of what AEs faced.
Added to this, the RBI hiked interest rates five times, cumulatively by 185 basis points, and that should have lagged impact on domestic inflation. It is also important to understand that rate hikes were meant largely to address the issue of external imbalances, following the sharp outflow of foreign capital that lead to the strengthening of the US dollar, and less to address domestic inflation issues.
The RBI also used its forex kitty to address this issue, which otherwise would have forced sharper interest rate hikes - the US Fed hiked the rate by 425 basis points in the current year while the RBI hiked it by just 185 basis points.
In terms of inflation expectations, going by the current global trends, the pressure on domestic inflation is subdued. However, its staying low is conditional upon the continuation of the fiscal-monetary strategy of the last two years that ensured macro stability.
But there are some risks as well. The prediction of La Nina and its effect is already showing up in the commodity futures market prices. Added to that, the surge in global fertiliser prices as well as continued supply chain disruptions means that inflationary pressures could stay for some more time.
To sum up, synchronised and aggressive monetary policy tightening across the AEs and emerging market economies appear to have helped ease inflationary pressures globally and also in India. While there are some upside risks, a continuation of prudent macro measures in India should help contain any further build-up of inflationary expectations and help in reviving the economy in the medium term.
N R Bhanumurthy is Vice Chancellor of Dr BR Ambedkar School of Economics University, Bengaluru. Views are personal, and do not represent the stand of this publication.