‘Rate increases may not cool price gains driven by war’

The Reserve Bank of India’s interest rate increases may not be able to ‘meaningfully’ cool prices while sacrificing growth, as almost three-fifths of the spike in India’s retail inflation since February can be linked to the Ukraine-Russia conflict, SBI’s economic researchers wrote in a report on Monday.

“In a situation of incipient demand recovery post COVID, the question will be whether growth could be a large casualty in case of large and persistent rate increases, even as inflation prints will continue to be of serious concern,” the SBI economists led by group chief economic adviser Soumya Kanti Ghosh wrote.

Inflation measured by the Consumer Price Index (CPI) hit a near eight-year high of 7.8% in April, with rural inflation hitting the highest level in 96 months at 8.4%. The RBI, in an off-cycle meeting this month, raised benchmark interest rates by 40 basis points and began unwinding pandemic-related monetary policy accommodation.

“Against the continued increase in inflation, it is now almost certain that RBI will raise rates in forthcoming June and August policy and will take it to pre-pandemic level of 5.15% by August,” Mr. Ghosh noted. “However, the important challenge facing the central bank remains whether inflation will tread down meaningfully because of such rate hikes if war related disruptions do not subside quickly,” he added.

Inflation continues to be a bugbear and it looks unlikely that it will correct anytime soon, the report warned, adding that the impact in rural areas has been disproportionately higher on account of food prices, while fuel price impact and pass-through of higher costs by producers has had a similar influence on urban inflation, since the war in Europe began.

As per a dipstick study by SBI researchers to assess the ‘exclusive impact of war’ on the inflation trajectory in India, food and beverages, fuel and light, and transport contributed 52% of the overall increase in inflation since February. “If we also add the impact of input costs particularly on the FMCG sector, thus adding the contribution of personal care and effects, the total impact at an all-India level comes to 59%, purely because of war,” the economists wrote.  

While they endorsed RBI’s endeavour to quell inflation through interest rate increases, the economists noted that larger increases would possibly have an impact on nascent growth impulses. The RBI might also have to use a shorter window to address inflationary concerns ‘given the realpolitik challenges in the not so distant horizon’, they wrote.

The SBI economists also cautioned that wage growth, which had remained soft so far, could still feed into inflation which could then take time to moderate despite rate increases.