Opinion The price pinch: Despite RBI’s best intentions, inflation continues to hurt

In 2022, CPI inflation was above the upper threshold of the RBI’s targeting band for 10 consecutive months, which meant the target was not achieved for three quarters in a row. Inflation began softening towards the later part of the year. By December 2022, CPI inflation was down to 5.7 per cent. This led many to believe that the inflation peak had passed, and that inflation was on its way to the official target.

This optimism was misplaced. Underlying inflationary pressures still persist. The softening of inflation in November and December 2022 was largely driven by a steep fall in vegetable prices. Excluding vegetables, CPI inflation was in fact more than 7 per cent. The misplaced optimism has now become evident. The January 2023 CPI inflation came out to be 6.5 per cent, once again crossing the upper threshold of the RBI’s inflation targeting band.

The risks to inflation have continued unabated over the last few months and have contributed to the latest spike in inflation as well.

First, with food accounting for 46 per cent of the overall CPI basket, a rise in food inflation from roughly 4 per cent in December 2022 to almost 6 per cent in January 2023 has played an important role in overall inflation going up. Within food, one component that has proved rather stubborn is cereal inflation. Between May and December 2022, year-on-year cereal inflation nearly doubled from 5 per cent to 14 per cent. In January 2023, this increased to 16 per cent. Within cereals, inflation in wheat has been steadily going up. Between May and December 2022, wheat inflation increased from 9 per cent to 22 per cent. It increased even further to 25 per cent in January 2023.

The steep rise in wheat prices reflects shortages. Data from the Food Corporation of India shows that stocks in government warehouses declined from 33 million tonnes in January 2022 to 17 million tonnes in January 2023. The government has recently approved a release of three million tonnes in the open market. However, this is insufficient to restore market supplies. Given that the next harvest will not be ready till April, and government stocks in February are further down to 15 million tonnes, this source of inflationary pressure is likely to persist for a while.

Second, core (non-food, non-fuel) inflation in January came out to be 6.2 percent. This is consistent with the unyielding core inflation of 6 per cent for nearly three years now. A persistently high core inflation implies that price pressures have become entrenched in the system. Part of this can be explained by the continued pass-through of high input prices to final goods prices. Interestingly, this is happening even when WPI (wholesale price index) inflation, which reflects input prices, has come down from a high of 16 per cent in May 2022 to less than 5 per cent in January 2023. This implies that with margins getting squeezed and profitability suffering, firms are spreading out the pass-through over a longer time period. This makes the core inflation trajectory uncertain.

Finally, external factors also play a role. Inflation in developed countries continues to be high (6.4 per cent in the US; 8.5 per cent in the EU; 10.5 per cent in the UK). India is importing some of this elevated inflation through international trade in goods and services. Moreover, with China gradually opening up its economy after nearly three years of zero-Covid restrictions, commodity prices are likely to go up, which could exert renewed pressures on India’s inflation.

What have the policymakers been doing to address the inflationary concerns?

The government has done its bit by announcing a conservative Union budget for 2023-24. It has accorded primacy to much needed fiscal consolidation, and has refrained from announcing populist measures that could have arguably fuelled demand, and hence inflation.

The RBI has been doing its job as well. It increased the policy repo rate from a pandemic low of 4 per cent to 6.5 per cent in a span of 10 months. It has also adopted a hawkish tone, as evident from its latest monetary policy statement. Unlike last year, when despite rising inflation, the monetary policy statements did not contain any forward guidance, the RBI, in its February 2023 statement, emphasised the importance to “remain alert on inflation”, thereby hinting that the monetary tightening cycle is not over yet. Is there anything else that the central bank can do?

Having missed the inflation target for three consecutive quarters in 2022, the RBI had to submit a report to the government describing a plan of action that would help bring inflation down. The law does not require either the RBI or the government to disclose the contents of this report. However, given that inflation is proving to be difficult to rein in, and that the 4 per cent target is not likely to be achieved next year either, releasing the report to especially highlight the remedial actions that the RBI plans to undertake might help stabilise inflation expectations, and facilitate the central bank’s own endeavour to fight inflation.

A credible glide path to bring inflation down to the target level is of critical importance, particularly now with the national elections around the corner.

The writer is assistant professor, Indira Gandhi Institute of Development Research