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Tuesday, September 28, 2021

RBI must carefully chalk out path of policy normalisation, be mindful of upside risks to inflation

Even as the withdrawal of its accommodative measures is likely to be gradual — in line with evidence that a durable economic recovery is taking shape — the central bank must be mindful of the long-term costs of ignoring inflation.

By: Editorial |
Updated: August 19, 2021 9:03:33 am
The decline in inflation at both the wholesale and retail level is in part driven by lower food inflation.

In the State of the Economy report released on Tuesday, economists at the Reserve Bank of India (RBI) appear to be rather optimistic about the trajectory of inflation going forward, downplaying the threat of price pressures building up in the economy. The report notes that the “recent upsurge has peaked and the worst is behind us”, adding that inflation “is likely to stabilise during the rest of the year”. Recently released data does seem to corroborate the view that inflation at both the wholesale and retail level has peaked. Data released on Monday shows that the Wholesale Price Index (WPI) cooled for the second straight month, falling to 11.2 per cent in July, down from 12.1 per cent the month before. Similarly, data on retail inflation released last week also showed that the consumer price index (CPI) had moderated to 5.6 per cent in July, after breaching the monetary policy committee’s (MPC’s) upper threshold of 6 per cent in the previous two months. Till now, the MPC has also justified the stance of monetary policy on grounds that the uptick in inflation is transitory in nature, and is likely to abate as supply-side disruptions ease. However, inflation may well prove to be sticky on the downside. Price pressures may build up in the economy during the second half of the year, making it difficult for the MPC to continue to justify its current policy stance.

The decline in inflation at both the wholesale and retail level is in part driven by lower food inflation. At the wholesale level, the primary food index was at the same level as it was a year ago, while at the retail level, the food price index eased to 3.96 per cent in July, down from 5.15 per cent the month before. Even core inflation has moderated at the retail level. However, worryingly, segments such as transport and communication, education and personal care, all have seen an uptick. Part of this can be traced to higher fuel prices. The pass through of higher commodity prices — RBI’s own surveys suggest that firms “expect to pass on the cost burden to the consumers in Q2 by increasing selling prices” — along with demand-side pressures which are likely to surface towards the second half of the year as household demand recovers, suggest that inflation may well continue to remain elevated.

So far, the RBI has treaded cautiously, sidestepping calls to review its policy stance, mindful of the consequences of premature tightening. While it continues to attach primacy to reviving growth, considering that inflation remains elevated, it must carefully chalk out the path towards policy normalisation. Even as the withdrawal of its accommodative measures is likely to be gradual — in line with evidence that a durable economic recovery is taking shape — the central bank must be mindful of the long-term costs of ignoring inflation.

This editorial first appeared in the print edition on August 19, 2021 under the title ‘A sticky problem’.

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