The Reserve Bank of India (RBI) has a new inflation worry as the rupee depreciation against the US dollar has increased the risk of imported inflation via crude oil and commodity prices. The second Covid wave is also expected to upset the RBI's inflation calculation as local lockdowns impact supply chain and logistics.
The current retail inflation or consumer price index (CPI) is already hovering closer to the uppermost band of 6 per cent. The RBI has the mandate to maintain inflation at 4 per cent with a band of +-2 per cent. The CPI inflation numbers for March were released days after the monetary policy announcement in early April. CPI inflation in March stood at 5.52 per cent as against 5.03 per cent in February 2021.
In its first bi-monthly monetary policy for 2021-22, the RBI revised its inflation projection slightly upward to around 5.0 percent in 2021-22. Exactly two months ago, the RBI had forecasted CPI of 5.2 to 5 per cent in the first half (April to September) of 2021-22. The revised projection for the first half is at 5.2 per cent.
Similarly, the RBI's third-quarter projection has been revised upward from 4.3 per cent earlier to 4.4 per cent. The RBI has also released its estimate for the fourth quarter (January-March), which is at a higher level of 5.1 per cent.
The outlook for rupee remains uncertain amid fresh Covid wave. The rupee value against the US dollar saw a sharp rise in October 2018 when it touched the levels of 73-74 a dollar. Thereafter, it gradually declined on the back of dollar inflows and by December 2019, the rupee was below 70 levels.
High volatility in the currency restarted in 2020 due Covid-led uncertainty and inflow of dollar. In the last two months, the rupee has seen a sharp jump from 72 levels to 75 levels. The rupee is weakening because of the RBI's push to support lower G-Sec yields. The RBI has committed in the market that it would do everything necessary to keep the yields low. The RBI as a debt manager of the government also has a responsibility of managing the government's borrowing programme.
As a result, the surplus liquidity in the system will be inflationary and erode the currency value. The rising US yields and falling G-Sec yields in the domestic market are also narrowing the interest rate differential for global investors that are present in India. The risk for equity investors especially FIIs is also rising because of recovery uncertainty post the second Covid wave.
The second covid wave is also spreading much faster with the country reporting over 2 lakh cases in a day. There are half a dozen states from Maharashtra, Karnataka, Kerala to Chhattisgarh from where most cases are getting reported.