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India’s uncertain growth trajectory makes it tough for RBI to tinker with interest rates

There are some early signs of moderation in inflation and a pick-up in growth, but RBI is likely to monitor growth and inflation before a decision on changing rates.

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The Reserve Bank of India (RBI) is expected to leave interest rates unchanged in its monetary policy review this week. With economic growth slowing and softening of commodity prices, the pressure on the monetary policy committee to raise rates has also eased.

The rise in prices in India the last few months was mainly due to higher global crude oil prices, commodity prices and supply side disruptions. International food prices have also seen a decline in June. This is primarily due to a decline in prices of vegetable oils and cereals. 

Food and fuel

Retail price inflation in India remained high at 6.23 per cent in June 2021, after recording a surge of 6.3 per cent in May. This was the second consecutive month when inflation had remained above the RBI’s upper tolerance band of 6 per cent.

Food price inflation, the largest component of CPI, inched up to 5.15 per cent in June from 5.01 per cent in May. The rise in food prices was primarily on account of surge in prices of vegetable oils, pulses and fruits. In particular, vegetable oil prices grew by 34.8 per cent in June.

The rise in global crude oil prices reflected in higher inflation in the ‘fuel and light’ and ‘transport and communication’ segments. Inflation in the fuel and light segment has been in double-digits in the last two months. ‘Transport and communications’ also recorded a double-digit inflation primarily on account of petrol and diesel inflation.

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Import driven inflation showing signs of moderation

The inflationary pressures seen in the last two months were largely import driven. Prices of vegetables oils, commodities and crude oil have been rising steadily over the last few months, putting an upward pressure on domestic prices.

However in the last one month, some initial signs of moderation in global prices are emerging.

World food prices measured by the FAO Food Price Index (FFPI) showed a decline in June. The FFPI tracks the international prices of commonly-traded food commodities. It declined by 2.5 per cent in June as compared to the previous month. The drop reflected a decline in the prices of vegetable oils, cereals and dairy prices.

In particular, the FAO Vegetable Oil Price Index fell by 9.8 per cent from its May value. The decline in prices is driven by seasonal production gains and subdued import demand. The fall in international prices of vegetable oils would likely get reflected in lower domestic prices in the coming months.

Global crude oil prices are also expected to decline in the coming months as countries in the OPEC+ group have settled their internal dispute and agreed to boost production of crude oil from August. Meanwhile, the demand for crude oil could take a hit due to resurgence in Covid cases in the US and other major oil consumers.

Global non-energy and non-food commodity prices have also started showing signs of easing in July after registering an increase over the last few months.

For instance, the World Bank Commodity Price Index for base metals has eased in the last two months. Base metals such as steel serve as raw materials in a number of industries like automobiles and construction. With commodity prices subdued, the prime upside risks to inflation appear to have subsided for now.

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Supply-side disruptions easing

In addition to imports, the recent rise in prices was driven by supply-side disruptions induced by localised lockdowns. With gradual unlocking and normalisation of economic activity, supply-side disruptions will ease and will lead to reduction in prices.

The southwest monsoon has started showing signs of revival and has managed to cover some of the deficit seen between June-end to mid July. The sowing of kharif crops has since gathered pace. This will further ease inflationary pressures.

Uncertain growth trajectory

There are mixed signals on the growth front. The RBI in its July bulletin had noted that while tapering of the second wave and a pick-up in vaccination drive has brightened near-term growth prospects, a sustained demand recovery is yet to take shape.

The recovery that got interrupted due to the second wave has since shown some early signs of a pick-up. The Manufacturing Purchasing Managers’ Index (PMI) rose to 55.3 in July from 48.1 in June.

The goods and services tax collections in July at Rs 1.16 trillion also corroborated the uptick seen in the manufacturing PMI. Auto sales also picked up in July as Covid-related restrictions eased.

However, the services sector PMI remained in the contraction zone in July.

While there are some early signs of moderation in inflation and a pick-up in growth, RBI would likely monitor the trajectory of growth and inflation including global developments over the coming months before deciding on tinkering with interest rates.

Ila Patnaik is an economist and a professor at National Institute of Public Finance and Policy.

Radhika Pandey is a consultant at NIPFP.

Views are personal.

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