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Rising inflation makes RBI's task harder

Reserve Bank of India
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Reserve Bank of India

Highlights

Everything was going well in terms of economic progress of the country from the third quarter due to better financial result shown by corporates and other favourable conditions

Everything was going well in terms of economic progress of the country from the third quarter due to better financial result shown by corporates and other favourable conditions. However, the recent retail inflation, wholesale inflation and IIP numbers seem to have disturbed the applecart. CPI inflation rose by100 bps in February to 5.03 per cent led by unfavourable base effect, much lower sequential correction in vegetable prices, higher energy and transportation prices and select sequential increase in core goods inflation.

The wholesale inflation also hit a 27-month high of 4.17 per cent in February. It rose for a second consecutive month as prices of food items, power tariffs and fuel rates went up. As per official data, food inflation registered a 1.36 per cent upswing last month. In January, it was (-) 2.8 per cent. Wholesale inflation in pulses was 10.25 per cent. In fruits, it was 9.48 per cent.

Experts say wholesale price index (WPI)-based inflation will further go up to six per cent in March. If this prediction comes true, it will be a real piece of bad news for the economy, markets and RBI.

Further, IIP lost momentum again in January and contracted 1.6 per cent, thanks to poor manufacturing activity and muted consumer demand. After the rapid recovery was seen till October 2020, the trend in the IIP turned volatile in the last three months, indicating that the economy has entered into a consolidation phase with an underlying momentum that is relatively subdued. While the overall demand condition remains patchy, one can assume that continued traction in economic activity and rising input costs will weigh on the inflationary pressures.

In spite of March inflation tracking 5.5 per cent, the RBI's Q4FY21 forecast could see a 25-30 bps cut, in Emkay Global Financial Services' view. It adds that the headline inflation may average 4.5 per cent in FY22E (estimate) against 6.2 per cent in FY21E, assuming that the food inflation normalises. Similarly, ICRA had anticipated deterioration in the IIP's performance in January 2021. In particular, the slippage of consumer goods manufacturing back into a year-on-year de-growth in January is a key disappointment.

The steep fall in the performance of capital goods in January was led by an adverse base effect, which is expected to be transient. Unfortunately, the pointers about the forthcoming monthly data on the IIP front are not encouraging due to low consumption, less spending by corporates and the government's ever-increasing spending for the country's Covid vaccination drive. These factors are likely to make a dent in the wheels of otherwise moving economic growth.

If that happens, RBI is unlikely to continue its accommodative stance let alone reducing the interest rates. Chances are dim that the apex bank, which will review its annual monetary policy early next month, will soften key rates. RBI must listen to what Raghuram Rajan in the past. The former RBI governor has warned against drastic changes in monetary policy.

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