The promise of a quick vaccine, India’s higher-than-expected gross domestic product (GDP) figures for the quarter ended September, and a booming stock market suggest that risks to growth may be waning. But there is still a big obstacle: persistently high inflation. And it may well represent the greatest threat to the country’s incipient economic recovery.
Inflation has been moving above the Reserve Bank of India (RBI) target range of 2-6% throughout this year. Until now, members of the RBI’s Monetary Policy Committee (MPC) have chosen to tolerate peak inflation even as they maintained loose monetary policy to jump-start growth. As the MPC meets again to decide on policy rates this week, relentless inflation may test its tolerance.
In a rare comment a few days before the MPC meeting, Mridul Saggar, a member of the MPC and a senior RBI official, said that high inflation leaves little room for the MPC to cut rates now. He spoke at the Emerging Markets Central Banking Summit hosted virtually by the Washington-based Institute of International Finance last week.
To be sure, many economists expect inflation to cool down in the coming months. As food prices fall due to a bountiful harvest and supply chains disrupted by the pandemic are repaired, inflation will no longer be as big of a risk as it is now, they say. But they have been misreading the inflation that leaves the tea during the last months. Since April, most economists have argued that high inflation will be “transitory.” However, it has assumed a year-round permanence, driven largely by high food prices.
Saggar declared himself powerless in the battle against food prices, saying that the MPC lacks the firepower to deal with food prices. However, food prices can play a role in shaping inflation expectations, and thus end up influencing headline inflation figures by increasing wages and costs. In fact, this was precisely the reason cited by Urjit Patel’s committee for targeting headline inflation in its 2014 inflation targeting report.
Household inflation expectations have remained high since April, the RBI survey data shows.
It is worth noting that the actual path of inflation has often deviated from inflation expectations data. Some economists also suggest that household inflation expectations may be strongly influenced by current inflation rates. However, persistent inflation may toughen inflation expectations and make it even more difficult to control in the future.
The global environment has been benign so far, but the tide may be turning. Easy money has already boosted equity prices globally as equity markets are awash with liquidity. As prospects for a global recovery improve, commodity markets could also be flooded with new liquidity in the coming months. The sharper the global recovery, the greater the chances of a commodity boom.
For India, a net importer of commodities such as crude oil, this could become a challenge, said Anubhuti Sahay, head of South Asia research at Standard Chartered Bank Plc. Compared to its key peers in emerging economies, India is much more vulnerable to a surge in world oil prices.
Sahay also said that policy-driven price pressures, such as increases in excise duties on various fuel products, are unlikely to be reversed anytime soon and will remain a challenge in the future.
There are also long-term demographic shifts globally that may end the era of low inflation, warns a new book by economists Charles Goodhart and Manoj Pradhan, The Great Demographic Reversal.
Governments around the world would need to spend more and more money to support aging populations. This would add to fiscal stress and raise inflation. A declining workforce also means more consumers than producers, adding to inflationary pressures. Tensions over globalization and growing mistrust in China could fragment supply chains and increase these price pressures, Goodhart and Pradhan argue.
Also, as the workforce shrinks and globalization weakens, workers would gain more market power and could bargain for higher wages. All of these forces would conspire to end a long era of low global inflation, the authors argue. For countries like India that have struggled to control inflation even in a benign global environment, the outlook looks terrifying.
Low growth, rising public debt, and incessant domestic inflation have already created an unfavorable situation before the MPC meeting. The prospects for a global inflationary spiral only add to the growing list of inflationary threats.
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