Indian inflation has been outside the tolerance band of the Reserve Bank of India (RBI) for 10 out of the 16 months since April 2020, which was the first full month after the pandemic hit economic activity. The new monetary policy framework says that the Indian central bank has failed in its main task of keeping inflation under control if average inflation is more than 6% for three consecutive quarters. That did happen in the first three quarters of fiscal year 2020-21, from April to December, but the fact that government statisticians were unable to collect enough data from retail markets during the first national lockdown meant that inflation estimates for those months were not considered reliable enough to go into RBI’s record. That is understandable.
Price pressures did seem to ease during December 2020 and January 2021. There was also a sharp fall in April 2021. However, inflation jumped again after these short respites. The July data also offers some hope. Inflation in consumer prices came down more sharply than expected. It is quite likely that it will continue to drift downwards over the next few months, helped by the high base of the corresponding months in the previous year. RBI estimates that average inflation will come down from 5.9% in the second quarter to 5.3% in the third quarter, before it accelerates again to 5.8% in the fourth quarter of the ongoing fiscal year.
Central banks around the world say that the recent increase in price pressures is because of disruptions in supply chains, rather than excess demand. They are also wary of premature withdrawal of monetary policy support from economies that are not yet out of the woods. The Indian central bank broadly makes the same argument, though the minutes of the latest meeting of the monetary policy committee (MPC) clearly shows that there are now concerns about staying on the current path for too long. The bond-market consensus is that monetary policy normalization will move forward in four steps: Money-market rates rising to get back into the policy corridor, an increase in the reverse repo rate, a change in the monetary policy stance from accommodative to neutral, and finally an increase in the repo rate. This will unfold very gradually, rather than in sudden leaps that can unsettle the bond market as well as the underlying economy.
This is also a good time to see where India stands on the inflation front compared to the other major economies. The sharp spike in US inflation has obviously captured a lot of attention. There are rising inflation concerns in some other countries, such as Germany. Indian inflation is still comparatively high compared to other major economies, both in developed and emerging markets. Countries such as Brazil, Mexico, Turkey, Pakistan and Russia have higher inflation than India does. Argentina is a clear outlier, with an inflation rate for July in excess of 51%.
Another way to examine the international price situation is to look at where inflation is compared to the targets given to central banks in various countries. I took a look at 35 major economies with formal inflation targets, including the multinational euro area. In July, inflation in 24 of these economies was running ahead of their respective inflation targets (either their point targets or the middle of a range, depending on the formal mandate). Among the handful of exceptions that managed to keep inflation close to target were China, Japan, Britain, Sweden, Switzerland, Indonesia, Thailand and Israel. It will be interesting to see how many countries will eventually be able to keep average inflation for this year below or close to target.
The data presented above points to two facts. First, India has an inflation problem that has persisted for well over a year. Second, most other major economies are also struggling to keep inflation near their formal targets. The one big difference is that Indian inflation has been high right through the pandemic; most other major economies have seen resurgent inflation only after their economic recoveries accelerated. Most central banks will begin to pivot towards monetary policy normalization in 2022, assuming that the pandemic is under control. They have a difficult balancing act to manage. They must not act so rapidly that an economic recovery is halted in its tracks, but also not act so late that inflation expectations rise to levels that trigger a self-fulfilling cycle of price pressures.
Inflation expectations in India have begun to rise. There are now doubts over how the Indian central bank is interpreting its inflation targeting mandate. Has the inflation target in effect been moved from 4% to 6%, or from the mid-point to the upper end of the mandated range? The latter has been put in place for RBI to have some manoeuvring space to deal with issues such as weather shocks or incorrect inflation forecasts. The minutes of various recent MPC meetings show that members have been careful to make a distinction between the inflation target and its tolerance band, a subtle yet important distinction. It is thus important that the Indian central bank reiterates that its inflation target is 4%, which it will pursue once the pandemic shock eases.
This article was originally published in Livemint on 25 August 2021
The opinions expressed in this essay are those of the authors. They do not purport to reflect the opinions or views of CCS.