Friday May 13, 2022

Retail inflation in April rose by a worse-than-expected 7.79% year-on-year (y-o-y), driven by high prices of food and transportation. Food accounts for a chunky 45.86% of the index and the prices of cereal, which have a weight of nearly 10%, have been elevated on the back of global prices. The rise in edible oil prices has accelerated post the Russia-Ukraine hostilities and Indonesia’s ban on exports of palm oil. Experts believe prices of some food items—wheat, for instance—could go up further, given the expected shortfall in domestic output, now expected to be lower than 111 million tonnes, and the high prices globally.

Some experts believe this could spill over to rice. Of course, the impact of costlier far inputs, such as fertilisers, will all add to food costs. The inflation in transport and communication of nearly 11% y-o-y was expected.

What’s worrying is that just about half the increase in crude oil prices has been passed on to consumers by way of pump prices. Indeed, core inflation at 7% y-o-y remains uncomfortably high, with the rise in prices of miscellaneous items, suggesting inflationary pressures are becoming generalised. Higher electricity tariffs will add to the pain. There is also the concern that services inflation will begin to creep up soon, and will slow down only after the pent-up demand is satiated.

That is why the retail inflation may be peaking, but the descent will be a slow one. The trajectory will depend primarily on the longevity of the supply-side constraints for products such as edible oil and the course crude oil prices take. As of now, economists believe retail inflation would average 6.3-6.4% for FY23, staying at over 7% until September. If inflation does indeed ease over the next six to seven months, the Reserve Bank of India (RBI) may have an easier time, and perhaps the 5.5% terminal rate being suggested by economists is where the rate hiking cycle may end. That would be a little over the 5.15% that the repo was at in March 2020, before the pandemic hit. However, that is far out, and in the near term, the Monetary Policy Committee (MPC) is expected to vote for hikes of 40 bps in June and 35 bps in August on the back of 40 bps out-of-cycle hike in early May. The MPC would be justified in doing so. There is absolutely no denying the need to tame inflation and prevent expectations from becoming unanchored as the second-round effects—higher wages and rents—play out. Given that RBI left it a little too late, it will need to raise rates in big chunks as it catches up.

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The big worry is the growth engine seems to be sputtering. Factory output for February grew at an anaemic 1.5% y-o-y on the back of a very weak base of a negative 3.5% y-o-y in February 2021. The growth in March was a subdued 1.9% y-o-y, off a high base of 24.2% in March 2021. The latter grew on a contraction of 18.7% in the corresponding month of the previous year. Worryingly, the capital goods sub-segment grew by 0.7% y-o-y, while intermediate goods grew by 0.6%. To be sure, the readings are somewhat difficult to assess because of base effects, especially the contraction in the consumer staples and durables segments. The commentary from manufacturers and volume data from fast-moving consumer goods and consumer durables firms suggests demand was muted in the March quarter. There are some bright spots such as construction, and all data on home sales is encouraging. However, while stronger companies will weather the storm by passing on the rising input costs, the small and mid-sized firms, in the informal sector, will struggle. The problem is private sector investment remains incremental at a time when the fisc is under severe pressure and the government may not be able to fund its capex plans. That could leave FY23 GDP growth at sub-7%.


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