The surprise spike in retail inflation is expected to make it harder for the central bank to prioritize growth, putting its interest rate setting committee in a wait-and-watch mode at its next meeting on 4-6 August.Economists believe that though the monetary policy committee (MPC) would not increase rates or change its stance at the meeting, it would raise an alert over rising inflation. An increase in repo rate, they believe, is not likely before 2022, although there could be a reverse repo hike in the December quarter. Reserve Bank of India (RBI) governor Shaktikanta Das has said several times that the central bank would remain accommodative as long as necessary to support growth.
Inflation measured by the Consumer Price Index (CPI) came in at 6.3% in May, above the RBIs target band of 2-6%. Sameer Narang, chief economist at Bank of Baroda, said this is disconcerting from the MPCs standpoint, and that core inflation has changed gears and is likely to show some persistence.
If you look at the sub-categories, the higher inflation print is broad-based this time. Prices of key commodities are going up in June as well. There is some discomfort around this number, and the MPC will also feel it because if core inflation persists at this level, it might be difficult to bring it down in a hurry,” he said.
The consensus among economists is that the rate-setting committee will perhaps slightly raise its inflation forecast of 5.1% for fiscal 2022. They also expect discussions on the road map for exiting the accommodative stance, which was likely delayed by the second covid-19 wave.
A lot, though, would depend on the pace of covid-19 vaccinations, and whether it is able to negate the effect of a potential third wave. India has so far vaccinated 47.7 million people with two doses of covid-19 vaccines, according to data from CoWIN dashboard.
Another concern, of course, is the unabated rise in fuel prices. The central bank, too, has cautioned against inflationary pressures emanating from this segment.
Retail prices of petrol and diesel are linked to the international price of these fuels, and not that of crude oil, per se. Rise in global energy prices coupled with high domestic taxes has been pushing up fuel prices. However, crude oil, which accounts for about 90% of the cost of these refinery products, is the biggest determinant of the retail price of fuel.
While the retail price of petrol in Delhi stood at 96.41 a litre on Tuesday, in Mumbai, it is 102.58 a litre. Diesel cost 87.81 a litre in Delhi, whereas in Mumbai is 94.70 a litre.
According to price build-up of petrol at Delhi effective 1 June, though base price for petrol is 35.63 per litre, excise duty of 32.90 per litre and price charged to dealers to the tune of 35.99 a litre and value added tax of 21.81 a litre with dealer commission of 3.79 a litre, push the cost of petrol to 94.49 a litre.
Fuel inflation seems to be the main pain point as the high prices of petrol and diesel is increasing the cost of transportation and leading to a subsequent rise in food prices,” said Madan Sabnavis, chief economist at Care Ratings.
However, Sabnavis explained that the MPC will shift its focus to inflation only when it is confident that growth wont slip further. He attributed this to the stance RBI took last year when inflation was quite high, adding that the central bank may not worry about inflation up to 7-8%, considering it as a temporary phenomenon.
Others said that the MPC will wait for more data to see how the second wave has affected growth. Economists said that although RBI might still decide to look through the spike in inflation, it may not abate soon as the economy opens up to more demand-side pressures.
As such, we expect the weight assigned to inflation to gradually rise. In our base case, we expect the theme of policy normalization to begin in Q4 2021. We expect a 40-bps hike in the reverse repo rate in Q4, to correct the policy corridor back to 25 bps,” economists at Nomura said in a report on Tuesday.
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