Striking The Right Balance Is Key, Says RBI On Inflation Concerns
The Reserve Bank of India has reiterated its belief that the current bout of high inflation in India is driven by supply-side shocks and is likely to ease.
"The sense is that inflation will persist at these elevated levels for some months before easing in the third quarter of FY22 when the Kharif harvest arrives in markets," the central bank said in its monthly bulletin for July.
CPI inflation stayed above the monetary policy committee's tolerance band of 4(+/-2)% for the second straight month. In June, retail inflation was at 6.3%.
According to the RBI's analysis, the pick-up in inflation is driven largely by adverse supply shocks due to disruptions caused by the pandemic, including increases in margins and taxes. "There are also specific demand-supply mismatches as in the case of protein-rich food items, edible oils and pulses, which are being addressed by specific supply side measures."
The RBI paper called for more supply-side action to help ease inflation.
"Elevated international commodity prices, especially of crude, are also imparting cost-push pressures. These factors should ease over the year as supply side measures take effect," the paper said.
The central bank argued that striking a balance between inflation and growth is critical at this stage.
"What if central banks were to acquiesce to shrill cries from markets to respond pre-emptively to inflation pressures against the judgment that they're transitory?" it asked. Citing the example of the U.S. Federal Reserve's altered interest rate outlook via its dot plot, the paper said that this led to a reassessment of the reflation trade.
In India's context, the RBI paper said that a "solid increase" in aggregate demand is yet to take shape.
"Even with a 9.5% GDP growth in the ongoing financial year, there will be substantial slack in the economy and demand pressures may take some more time to become evident," the paper said. While several high frequency indicators of activity are recovering, a solid increase in aggregate demand is yet to take shape, it said.
To be sure, the second wave, coupled with an aggressive vaccination push, has brightened near-term prospects for the Indian economy. "On the supply side, agricultural conditions are turning buoyant with the revival in the monsoon, but the recovery of manufacturing and services sectors has been interrupted by the second wave."
With growth impulses remaining tentative and inflation rising, "central banks globally have put their inflation credibility on the line, challenging the market’s view by renewing their commitment to stay accommodative or to undertake a very gradual, multi-year adjustment," the paper said.
"The key, as in the rest of life, is to strike the right balance."