Dear RBI, Beware The Inflation Ides Of March

The Reserve Bank of India and the Monetary Policy Committee have been banking on inflation flattening out after an early-in-the-year surge. The central bank, however, has to contend with higher-than-expected inflation prints for the next few months as a number of items continue to see a sequential increase in prices.

CPI inflation stood at 6.07% in February—the highest since June 2021 and above the Monetary Policy Committee's target range for the second straight month. The data for March, which will come only after the committee's next review on April 8, will likely show another spike, suggests high-frequency commodity price data.

In March so far, the daily prices of 22 essential food items are up 2.6% month-on-month on an average compared to a fall of 0.7% month-on-month in February, according to a research note by Kaushik Das, chief economist at Deutsche bank dated March 22, 2022.

Inflation in oils and fats rose to 6.9% month-on-month in March, after a rise of 1.2% in February 2022. On an aggregate, inflation in food and beverages rose to 0.2% month-on-month compared to a fall of 0.1% last month. While prices in milk eased, the cost of oils, pulses and sugar has risen.

As such, inflation may hit 6.3% in March, and 6.4% in April, according to Das' forecast, and average 5.5% for FY23.

Alongside food, petrol and diesel prices have started rising after a hiatus of nearly 137 days.

Petrol and diesel prices have been raised three times in the past week. Cumulatively, until Friday, petrol and diesel prices had gone up by Rs 2.4 a litre, adding to inflationary pressures.

The surge in international commodity prices could push domestic CPI above target in the March-May period, said a research note by Rahul Bajoria, chief economist at Barclays. "Factoring in an 8% month-on-month rise in domestic pump prices in March, we are currently tracking CPI at 6.5% year-on-year," he said.

Beyond food and fuel, categories like clothing are adding to inflation.

Clothing inflation is likely to stay high, in line with trends seen in the textile component at the wholesale level over the past year, Bajoria said. Demand for other household goods and services will likely remain contained as the spike in prices of motor fuel and other commodities could temper domestic demand in the coming months, he said.

Broadly, inflation will stay high in the first half of FY23, with the peak likely to be closer to 7%, Suvodeep Rakshit, senior economist at Kotak Institutional Equities, said. Some part of the price pressures will need to be absorbed by the government through excise duty cuts in fuels, he added.

India’s inflation trajectory is now 150 basis points higher than it was pre-pandemic at about 5.5% forecasted even for FY24, Das said. Inflation expectations, too, are likely to settle higher than in pre-pandemic times, he added.

Monetary Policy Committee: Testing Its Limits

The continued rise in inflation pressures could test the MPC and the RBI's resolve to keep monetary policy accommodative till the economic recovery broadens out.

The central bank will review its growth and inflation forecasts at its meet in April, recent comments from RBI Governor Shaktikanta Das and Deputy Governor Michael Patra have suggested.

Patra, in a speech earlier this month, indicated that the Russia-Ukraine crisis and its immediate implications will be treated as a supply-side shock for the setting of monetary policy, suggesting the central bank may not react to it by shifting its stance or key policy rates.

With the upper threshold of its medium-term inflation target band as high as 6%, the MPC is likely to remain growth supportive for longer than other central banks and is unlikely to sacrifice growth to control imported inflation, said Aditi Nayar, chief economist at ICRA. "We foresee a shallow rate hike cycle with two increases of 25 basis points each in August-October 2022, regardless of the expected steeper U.S. rate hike cycle," she said.