Latest inflation data seems to corroborate fears articulated by the Monetary Policy Committee (MPC) in its December meeting when it refrained from cutting the benchmark repo rate. Retail inflation, as measured by the consumer price index (CPI), has surged to 7.35 per cent in December 2019, up from 5.54 per cent in November, according to data from the National Statistical Office. With headline inflation well above the RBI’s upper bound target of 6 per cent — it is expected to remain elevated in the coming months, may well surpass the RBI’s estimate for the second half of this fiscal year — it reduces the space for further easing of policy rates, even after clarity over the extent of the Centre’s fiscal slippage emerges. The 10-year G-sec yields have reacted sharply to these developments, rising to 6.67 on Tuesday, partially offsetting the impact of the RBI’s recent open market operations. This combination of weak economic activity and higher than expected supply-side inflationary pressures has put the inflation-targeting regime under test.
Much of the rise in the headline inflation number can be traced to higher food prices. Food inflation has risen to a near six-year high of 14.12 per cent in December 2019, up from 10.01 per cent in the previous month. Much of this spurt is due to vegetable prices, which have surged to 60.5 per cent in December, contributing nearly 3.7 percentage points to the headline numbers. Prior to this data, there was an argument for overlooking this spurt in food prices, and easing rates further, as this spike in inflation is likely to be transitory. But the price rise has been much more pronounced. And while vegetable crop cycles tend to be short, and supply-side pressures may ease in the coming months, the stickiness in prices of protein items is likely to provide a floor for food inflation. Put differently, food inflation is unlikely to revert to previous levels in the short term. And as household inflation expectations, a key metric in the MPC’s assessment, are more responsive to food inflation, this uptick will further exert upward pressure on them. Add to that the uncertainty over oil prices on account of hostilities in the Middle East, and the outlook for inflation looks muddled.
It was expected that the MPC would lower rates further once clarity over the Centre’s fiscal position emerges after the Union budget. But the current trends in inflation suggest that those expectations are likely to be belied. Space for further easing may now open up only towards the second half of the next fiscal year. Soon, attention will turn to the Union budget. With limited fiscal space for a meaningful stimulus, the finance minister should spell out how the government intends to support the economy during this rough patch, and return growth to a higher trajectory.
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