Why inflation stands in the way of India’s growth recovery

Inflation has been hovering above the Reserve Bank of India’s (RBI’s) target range of 2-6% throughout this year. So far, RBI’s monetary policy committee (MPC) members have chosen to tolerate the inflationary spike even as they kept monetary policy loose to revive growth. As the MPC meets again to decide on policy rates this week, unrelenting inflation may test their tolerance.

In a rare comment just days ahead of the MPC meet, Mridul Saggar, an MPC member and a senior RBI official said that high inflation leaves little room for the MPC to cut rates now. He was speaking at the Emerging Markets Central Banking Summit organized virtually by the Washington-based Institute of International Finance last week.

To be sure, many economists expect inflation to cool in the coming months. As food prices come down because of a bountiful harvest and supply chains disrupted by the pandemic get repaired, inflation will no longer be as big a risk as it is now, they say. But they have been reading the inflation tea leaves wrong for the past several months. Since April, most economists have maintained that high inflation will be ‘transitory’. Yet, it has assumed a permanence throughout the year, driven largely by high food prices.

Saggar pleaded helplessness in the battle against food prices, saying that the MPC lacks the fire-power to tackle food prices. Yet, food prices can play a role in forming inflation expectations and thereby end up influencing the headline inflation numbers by driving up wages and costs. In fact, this was precisely the reason cited by the Urjit Patel committee to target headline inflation in its report on inflation targeting in 2014.

Household inflation expectations have indeed remained elevated since April, RBI’s survey data shows.

It is worth noting that the actual trajectory of inflation has often differed from the inflation expectations data. Some economists also suggest that household inflation expectations may be heavily influenced by current inflation rates. Nonetheless, the persistence of inflation can harden inflationary expectations and make it even harder to tame in future.

The global environment has been benign so far but the tide may be turning. Easy money has already boosted stock prices globally, as stock markets find themselves awash with liquidity. As prospects of a global recovery improve, commodity markets could also find themselves inundated with fresh liquidity in the coming months. The sharper the global recovery, the higher the chances of a commodities boom.

For India, a net importer of commodities such as crude oil, this could become a challenge, said Anubhuti Sahay, senior economist at Standard Chartered Bank. Compared to key emerging economy peers, India is much more…