The monetary policy dwelt at length on inflation, making it clear that price increases carry enormous weight in rate actions. The central bank’s concern over inflation is not misplaced given that there are numerous factors that can take it higher and the more vulnerable sections of society appear to be suffering more due to it.
While inflation is projected at around 5 per cent towards the end of 2016-17, the RBI Governor has mentioned that there are various factors that can derail these projections. One, the impact of the Seventh Pay Commission award has not been factored into these projections.
Two, these projections are based on the assumptions that monsoon this year will be normal, international crude oil prices will remain around $30 a barrel and the rupee will not depreciate too much from current levels.
Given the high level of uncertainty in the global environment centred around the performance of the Chinese economy and the monetary policy action of the US Federal Reserve, both the exchange rate and the price of crude oil may not stay put at current levels.
Rural India feels the pinch Recent inflation readings suggest that rural India is suffering more than urban India. While the growth in rural CPI inflation was 6.32 per cent in December, the increase in urban inflation was much lower at 4.73 per cent. There is also a sharper increase in cost of services in rural areas when compared to cities. For instance, while healthcare costs increased 4.77 per cent in urban areas in December 2015 over December 2014, the growth in these costs in villages was higher at 5.94 per cent. Similarly, cost of transport and communication, recreation, education and personal care is also increasing at a faster rate in rural areas.
El Nino threat According to Bank of America Merrill Lynch, while food prices seem to be peaking, there is an increasing question mark on the 2016 south-west monsoon.
“The Southern Oscillation Index (SOI), which is a lead indicator for El Nino, has dipped to -22 (below -7 is El Nino), at a time when India’s rivers are flowing 25 per cent below normal. A saving grace is that the Australian weather bureau expects the El Nino to peak by H216,” says the report drafted by Indranil Sen Gupta. If El Nino peaks before June, the situation can be salvaged.
The inflation expectations survey, which is one of the key metrics that the central bank watches, has also not been very comforting. The expectation had dipped towards the end of December 2014 but it has begun creeping higher again since the start of 2015.
The survey also shows that retired persons, self-employed, housewives and daily workers are more worried about inflation rising higher than other groups. The mean growth in inflation, expected in September 2015, was 10.6 per cent. The rate of growth expected after three months and one year were higher at 10.7 and 11.1 per cent, respectively.
Given these numbers, it is not surprising that the RBI wants to go slow with its interest rate cut as it is imperative that inflation is kept under check to protect the vulnerable sections of the country.
Keeping inflation under check has other benefits too, as positive real interest rates are required to ensure that savings keep flowing into financial assets. The movement of the Indian currency is also, to a large extent, dependent on inflation.