ExplainSpeaking: Inflation has already stumped the common man. Is RBI next?

Typically, it does so by meeting every second month and tweaking the repo rate, which is the interest rate that the RBI charges when it lends money to the banking system. During times of high inflation — when inflation goes above 6% — the MPC raises the repo rate. This makes all existing and new loans costlier — be it for a car or home or factory — and that, in turn, reduces the demand for goods and services in the economy. With overall demand dented, prices are expected to cool down because less money is chasing the same set of goods in the market.

On August 10, the MPC will announce its decision. Most people expect the RBI to maintain the status quo — that is, not change the repo rate on Thursday. But there is a very good chance that the RBI may find itself wrong-footed when the official inflation data for July is released on August 14.

That’s because private data collectors and analysts such as the Centre for Monitoring Indian Economy (CMIE) expect retail inflation to shoot well outside the RBI’s comfort zone (2% to 6%).

“Retail inflation, measured by the Consumer Price Index (CPI), is expected to catapult to around 7 per cent in July 2023, with a tendency to inch towards 7.50 per cent,” according to CMIE estimates released last week.

What is driving up inflation?

By law, the RBI has to target a 4% inflation rate. The law also provides a so-called comfort zone for the RBI — between 2% and 6% — within which retail inflation can vary. However, as CHART 1 shows, since late 2019, retail inflation has stayed above the target rate, and often even outside the RBI’s comfort zone.

For past 5 years, retail inflation has stayed away from the comfort zone of 2 to 6%

Since March, however, retail inflation has come within the comfort zone. This was also the time — April meeting, to be precise — when the RBI decided to stop raising the repo rates.

However, most analysts expect the trend to reverse quite sharply once the July data comes through.

Data for July will be released next week — four days after the RBI has made its decision. But as most Indians know, July saw a massive surge in food inflation and it is this inflation that is spiking the overall inflation rate. Food items account for almost 46% of the overall index that is used to measure inflation rate. To be sure, the inflation rate for any month is essentially the percentage change in the prices over the same month a year ago.

But not all food items contributed equally. CHART 2 shows the three main culprits within the food items category.

Chart 2: Food inflation rate likely in July

The biggest price rise is likely to have happened in vegetable prices. The inflation rate for vegetables is expected to be almost 37%. In other words, vegetables in July were 37% costlier than July 2022.

Within vegetables, the main culprit was tomatoes. Inflation rate in the prices of tomatoes in July is expected to have shot up by a mind-boggling 218%. Other vegetables such as onions also became pricier but by a comparatively much small degree — just about 9%.

The other big spurt in prices was in spices. Inflation rate for spices in July is expected to be almost 28%. The main culprit here were the prices of Jeera (which went up 86% in July) and turmeric (which went up 37%).

The third noteworthy trend is that of cereals such as wheat, rice, oats and millets etc. The inflation in cereal prices has been in double-digits since September last year. These numbers explain why the government has been trying to hold back India’s exports of wheat and rice.

As a result, food inflation in July is expected to jump to 12%.

Thalinomics: How is inflation hurting the food budget?

The sharp rise in food inflation is not just a matter of academic interest; it has already started wrecking the household budget.

CHART 3 by CRISIL shows that the vegetarian Indians are getting hit the most.

Chart 3: Cost of veg and non-veg thalis up in July

The cost of vegetarian and non-vegetarian thalis were up 28% and 11% month-on-month, respectively, in July, according to a CRISIL report. Month-on-month data compares prices between two successive months instead of the same month for two successive years.

What’s been RBI’s recent stance?

The RBI had been forced to start raising repo rates after inflation hit an 8-year high (the highest since PM Modi took charge) in April 2022. As a result, the RBI started raising repo rates aggressively from May 2022 onwards. However, it surprised many when it stopped raising rates in April. Read this edition of ExplainSpeaking to understand why.

Simply put, when RBI decided to pause in April, it did so with inflation data only up until January (6.5%) and February (6.4%). In both those months, the inflation rate was above the comfort zone.

Many had argued that the April pause suggested that RBI had effectively abandoned the 4% target and was hoping to boost economic growth at the cost of slightly higher inflation rate.

But there was always a risk in this strategy: What if inflation rebounded because of a spike in food prices?

Those apprehensions seem to have come true.

What’s likely to happen?

At all times, RBI has to balance the needs of boosting the economy (for which it might want to cut the repo rate) and maintaining price stability (for which it might want to raise the repo rate).

Even under normal circumstances, this is tricky to strike the right balance. What makes RBI’s job tougher now is the timing: India is fast approaching the next general election, not to mention a clutch of state Assembly elections.

As such, the voter might be sensitive on both counts — inflation and growth. High inflation, especially food inflation has historically cost many governments. But containing inflation almost always comes at the cost of economic growth. Slower growth implies even slower job creation and likely increase in unemployment levels.

The key question for RBI, as it deliberates over the next three days, is: Does it expect this latest surge in inflation to be a temporary one or does it view this spike with the potential to fuel further inflation in the coming months?

What do you think is the bigger political threat: High inflation or high unemployment?

Share your views and queries at udit.misra@expressindia.com

Until next time,

Udit