Adopt a pragmatic policy on inflation

Most analysts expect RBI to continue to raise interest rates over the course of the year in an effort to combat inflation. While raising interest rates might help anchor inflation expectations and calm financial markets, this is bound to hurt the growth prospects of the economy.

Wholesale inflation in July (as measured by the Wholesale Price Index or WPI) grew at 13.9% on an annual basis. This is the second consecutive month of moderation in wholesale prices, not just on an annual basis but also on a month-on-month one.

Both retail and wholesale inflation seem to have peaked and are on a downward trajectory now. (Hindustan Times)

This is an unambiguous piece of good news. Both retail and wholesale inflation seem to have peaked and are on a downward trajectory now. Retail inflation, as measured by the Consumer Price Index (CPI) rose 6.7% in July compared to the 7% print in June. The July WPI has fallen from its 15.2% reading in June. Both retail and wholesale inflation have dipped for two consecutive months.

The welcome trend of inflation moderating should not lead to complacency, though. Even though inflation is falling, its level is far from comfortable. The Monetary Policy Committee of the Reserve Bank of India expects CPI to be above the 6% threshold – this is the upper limit of RBI’s comfort band – till the end of this calendar year. WPI continues to grow in double digits despite a high base (it was over 10% a year ago). These kinds of inflation levels are bound to cause pain across the economic spectrum.

This raises the question of what the appropriate policy response ought to be. Most analysts expect RBI to continue to raise interest rates over the course of the year in an effort to combat inflation. While raising interest rates might help anchor inflation expectations and calm financial markets, this is bound to hurt the growth prospects of the economy. Given the fact much of the current inflation is on account of external supply side disruptions and their cascading effects, rather than the domestic economy overheating, there is a case for monetary policy being more pragmatic than unnecessarily hawkish.