the story So Far: India’s retail inflation eases to three-month low of 6.77% in October When compared to the same month last year. Wholesale price inflation also eased to 8.3% in October from rising at double digits in the prior months. The fall in inflation has raised hopes that the RBI has been able to get a handle on price rise.
What is the reason for the fall in inflation?
Economists attribute the decline in inflation in October to a favorable base effect. It must be remembered that since the pandemic, retail inflation has been hit by the lockdown which has dealt a severe blow to the economy. Lockdowns affected both the demand and supply side in different ways, when they were first imposed and later when they were lifted by the government. This could lead to unusual volatility in inflation data since the pandemic. Therefore, it may be difficult to compare the inflation data for the current year, in which the economy has largely returned to normal due to the stringent lockdowns of previous years. A decline in food prices has also been cited as one of the reasons for the recent decline in inflation. But it must be remembered that inflation refers to a general increase in the price level regardless of changes in individual prices. Therefore, a rise or fall in inflation cannot really be attributed to changes in the prices of individual goods and services.
How will RBI react to the latest inflation data?
Retail inflation at 6.77% is still above the RBI’s target inflation range, which is between 2% and 6%. In fact, retail inflation has remained above the RBI’s target inflation range for the past ten months, prompting the RBI to explain to the government why it failed to meet its inflation mandate. Therefore, despite a modest reduction in inflation, economists expect the RBI to continue raising interest rates in the coming months; RBI may want to bring down inflation to around 4%. However, they expect the rate hike to slow down as inflation gradually eases. It is to be noted that the RBI hiked rates by 50 basis points each in its last three Monetary Policy Committee (MPC) meetings this year. Economists believe that the RBI may opt for a hike of 35 basis points during the next MPC meeting to be held in December. If inflation continues to decline, the challenge for the central bank will be to moderate the pace at which it slows rate hikes. This is because there is usually a time lag between monetary policy and its effect on inflation, which makes the setting of interest rates a tricky affair.
Has inflation peaked yet?
It is not clear whether the fall in retail inflation in October marks the beginning of a permanent decline in the inflation data. In the past, inflation figures have calmed down temporarily only to rise again in subsequent months. Therefore, it is too early to conclude that the October inflation data marks a turning point in the inflation trend. Monetary policy makers are likely to be aware of this and may decide to wait and watch before signaling a decisive change in their policy stance. The RBI may also decide to continue the cycle of rate hikes due to external pressures, especially if domestic economic growth does not fall to dangerously low levels as rates rise. Although inflation in the US eased slightly to 7.7% in October, it is still above the US Federal Reserve’s inflation target of 2%. This means that the US Federal Reserve is likely to maintain its accommodative monetary policy stance into next year as well. If so, the RBI may be forced to raise domestic interest rates or dig deeper into its forex reserves to arrest the rupee’s fall against the US dollar.