WATCH OUT FOR INFLATION BURNS
Inflation, as measured by the consumer price index (CPI or the weighted average of prices of a basket of consumer goods and services), stood at 6.9 per cent in July, breaching the upper band of the Reserve Bank of India’s (RBI’s) inflation target for the fourth consecutive month. Inflation has been above the RBI’s prescribed target of 4 per cent (plus or minus 2 per cent, so the upper band is 6 per cent) for 10 consecutive months now. CPI inflation was expected to fall with the easing of the lockdown but the July numbers show it is rising again. This will have serious repercussions on the economy. The central bank’s rate cut spree is surely over. The RBI’s monetary policy committee (MPC), in its announcement on August 6, left the repo rate (the rate at which commercial banks borrow from the RBI) unchanged at 4 per cent and the reverse repo rate at 3.35 per cent.
Keeping inflation in check enables the RBI to drop key rates and drive growth, as it has attempted to do earlier. Since the lockdown started, the central bank has cut repo rates by 115 basis points (1 percentage point equals 100 basis points). However, with demand still sluggish, reviving growth will be a slow, painful process.
The pandemic has left all calculations on the inflation front in tatters; the lockdown led to higher food prices as even essential goods got stuck at the farms and on highways in the initial days. That situation improved with a pick up in goods movement during the ‘unlock’ phases, but inflation in food and beverages was still at a four-month high of 8.7 per cent in July 2020, a huge jump over the 2.3 per cent in the corresponding month of the previous year. A Care Ratings note ascribes the inflationary pressure to supply disruptions from localised lockdowns in the states in July. Double-digit inflation among sub-components like meat (18.8 per cent), oils (12.4 per cent), vegetables (11.3 per cent), pulses (15.9 per cent) and spices has driven food inflation higher. Pulses saw double-digit inflation for the 10th consecutive month, while spices and oils too have been in double digits for four months. Fuel prices were also up, on higher taxes levied on these products. The rise in gold prices added another 50 basis points to the inflation rate.
Experts forecast that supply-side disruptions will continue for some time. These disruptions will be on three fronts—labour, logistics and finance. Although the trend of migrants returning to their villages will ultimately reverse, it will also depend on a credible downtrend in Covid cases in the cities, which is yet to happen. Disruptions in logistics are mainly due to the selective reimposition of local lockdowns. But the most critical is the finance-led supply disruption, says an HSBC research note. As much as 85 per cent of India’s labour force is employed in the unorganised sector, in firms that depend too heavily on their daily cash flows and do not have the buffer to withstand big economic shocks. If the micro, small and medium enterprises (MSME) sector fails, it will lead to considerable supply-side constraints.
To keep these firms alive, the banking system needs to allocate credit efficiently. “But the banks themselves have become extremely risk-averse, fearing a mountain of bankruptcies and non-performing loans because of the pandemic,” says Pranjul Bhandari, chief economist at HSBC. Banks have not transmitted repo rate cuts to lending rates adequately. Credit growth, which was already weak, has weakened further over the pandemic months. “It is possible that the lack of funding will stoke inflation eventually,” she adds. HSBC expects the next rate cut by the MPC only in the first quarter of the next calendar year, that too by 25 basis points. Meanwhile, a note from Care Ratings says while supply disruptions in food components will maintain an upward pressure on food prices, the release of kharif crops into the markets could ease food inflation to some extent. But the larger disruptions remain, and they threaten to further derail the economy.