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Big headache for RBI's MPC! Inflation monster to grow bigger

Covid has created disruption in the semi-urban and rural areas, which were untouched in the first wave. The global commodity prices are also on an upswing

In its first bi-monthly monetary policy for 2021-22, the RBI projected a CPI of around 5.0 percent in 2021-22 In its first bi-monthly monetary policy for 2021-22, the RBI projected a CPI of around 5.0 percent in 2021-22

The Monetary Policy Committee (MPC) has kept the repo rate, the rate at which banks borrow short term funds from the Reserve Bank of India, low at 4 per cent since May last year. The RBI has been holding the rates low to support growth, but risk of inflation is now a new headache for the central bank. The wholesale price index (WPI), which was 2.5 percent in January, has shot up to 10.5 percent in April this year.

The consumer price index (CPI), which the RBI tracks for setting interest rates, was slightly lower at 4.2 percent in April as against 5.52 percent in March. But a lot has changed in the last one month. Covid has created disruption in the semi-urban and rural areas, which were untouched in the first wave. The global commodity prices are also on an upswing.

Companies are feeling the pinch of higher input costs, which will get reflected in the prices of final goods. The retail inflation numbers are already very close to 4 percent rate targeted by the MPC with a lower and upper band of 2 to 6 percent, respectively. In its first bi-monthly monetary policy for 2021-22, the RBI projected a CPI of around 5.0 percent in 2021-22. It remains to be seen if RBI revises its 2021-22 projections for inflation.

Let's look at various factors impacting inflation:

CRUDE OIL PRICE DANGER

Global oil prices are moving northwards with current level at $70 a barrel. There are expectations of demand improvement from China, the US, and the Europe. The vaccination drive globally is progressing very fast which makes a case for faster recovery and also higher crude prices. The longer term trend line for crude oil is also indicating a reversal in crude oil cycle.

Take for example, the Brent crude oil prices have jumped to $70 a barrel in just 15 months after touching a low of $20 a barrel in February last year. In India, the prices of petrol have already crossed Rs 100 per litre in some states. Higher petrol and diesel prices will show up in inflationary numbers.

Also read: RBI MPC meet on June 4: Fund managers expect status quo on interest rates

RUPEE OUTLOOK

The rupee has been showing signs of weakness since the last week of May. The rupee has depreciated to a level of 73 against the US dollar. While the dollar inflows and the forex reserves are more than adequate currently to take care of any high volatility, the outlook for rupee is looking very challenging. First, the stock market valuations look a bit stretched given the falling growth and the Covid second wave.

The US inflation and the yield are also hardening, which offer foreign investors a better alternative in the US to park their funds. Second, the trade is also expected to normalise for India. The country has seen a trade deficit as well as current account deficit for decades. If things normalise, the current account deficit is expected to rise, which is not a good news for rupee.

RISING EDIBLE OIL AND METAL PRICES

The commodity prices, apart from crude, are on the rise globally. Take for instance, the prices of vegetable oil, which is a big import product for India, has been showing signs of hardening. The metals, too, are on an upswing. Clearly, the consumer durable industry will see a rising input cost because of metal and steel prices, which will get reflected in the CPI going forward.

Also read: RBI's MPC begins discussions; repo rate likely to remain unchanged

COVID WAVE IN SEMI-URBAN AND RURAL AREAS

Unlike the Covid first wave, which was restricted to metros and urban centers, the second wave is more widespread in the semi-urban and rural areas. There is a strong likelihood of food prices getting impacted because of infections and also the local lockdowns affecting the supply chain issues.

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