RBI likely to cite supply side constraints, geopolitical tension for high inflation

Reserve Bank of India. (File)

Shaktikanta Das, the Governor of the Reserve Bank of India (RBI), had earlier said the central bank will not immediately release the details of the letter that it will write to the government explaining the reasons for inflation breaching upper tolerance level of the Monetary Policy Committee (MPC)’s target. However, the current macroeconomic developments give us good reasons to believe what the letter may cover reasons for inflation and expected path of MPC to control inflation.

The MPC’s inflation target was set at 4 percent with an upper tolerance at 6 percent, and a lower tolerance level at 2 percent. However, for the first time; between January and September, the inflation target has remained above the upper tolerance of the MPC for three consecutive quarters.

To tame inflation, the MPC increased the repo rate by a cumulative 190 basis points from 4 percent to present 5.9 percent till September. The monetary policy rates transmit to the real economy with some lag. The CPI inflation still remained at an elevated level of 7.4 percent in September.

The RBI letter is expected to cite global inflation and supply-chain constraints due to war as the main reasons for higher domestic inflation. The global factors had spillover impact on the domestic inflation through higher crude and commodity prices, although the commodity prices have come down recently to some extent. According to the IMF's projection, global inflation will increase by 8.8 percent in 2022 from 4.7 percent in 2021. The Russia-Ukraine war has created severe energy crisis in Europe. Moreover, the global food prices increased above 30 percent on a year-on-year basis in March and April.

Although global food prices have decreased recently, it is still about 12 percent higher compared to last year during the same period. Similarly, base metal prices grew above 30 percent year on year in February and March. All of these have made inflation a global phenomenon with most countries battling with stubbornly-high inflation that stayed above the target levels of their respective central banks.

Domestically, barring January and February, food inflation has remained above 6 percent during 2022 till September. Food prices had to go through various shocks in recent times. Among the food items, cereal prices have remained higher due to the heat wave in the northern parts of India that impacted the production of wheat. Moreover, uneven monsoon rains hit paddy sowing that required the government to ban export of broken rice. To add to all of this, floods in some of the regions, uneven spatial distribution of rainfall during monsoon and lower base of last year had resulted in vegetable prices remaining above 10 percent in the last seven consecutive months till September. The core inflation (excluding food and fuel) also remained elevated at about 6 percent.

As part of its future course of action to tame inflation the MPC is expected to continue with its rate hikes, and take the terminal repo rate to around 6.5-6.75 percent levels. Inflation is expected to be about 6.7 percent for 2022-23 with some moderation in the second half of 2022-23. However, with easing momentum, normal monsoons, and lowering of global commodity prices; inflation is expected to come down to about 5.1 percent in 2023-24.

Sudarshan Bhattacharjee is Principal Economist at Yubi. Views are personal, and do not represent the stand of this publication.