Is inflation the biggest problem the Indian economy faces at the moment? Recent statistics do not paint a rosy picture. Retail inflation increased to 7.4% in September, staying above the 6% upper threshold of the Reserve Bank of India (RBI) for the ninth consecutive month. This means that RBI has officially failed to meet its inflation-targeting mandate. Wholesale inflation, while it came down to 10.7% from its August print of 12.4%, was in double digits for the 18th consecutive month
Is inflation the biggest problem the Indian economy faces at the moment? Recent statistics do not paint a rosy picture. Retail inflation increased to 7.4% in September, staying above the 6% upper threshold of the Reserve Bank of India (RBI) for the ninth consecutive month. This means that RBI has officially failed to meet its inflation-targeting mandate. Wholesale inflation, while it came down to 10.7% from its August print of 12.4%, was in double digits for the 18th consecutive month in September. To be sure, the latest retail inflation number was in line with analyst estimates, and a rate hike in the December meeting of RBI’s monetary policy committee is almost a given even in any case.
The problem is that rate hikes might not be the best possible tool to deal with inflation at the moment.At least two reasons can be given to justify this argument. First, food prices, especially cereals and vegetables, are playing a bigger role in driving Consumer Price Index. While volatility in vegetable prices is pretty common, there is reason to believe that tailwinds to cereal prices result from adverse climate shocks to wheat and, more recently, the rice crop. This is unlikely to ease soon, and monetary policy interventions have no relevance in dealing with higher food prices. Second, although a moderation in international commodity prices has provided some respite on the inflation front, even non-food prices continue to be above comfortable levels — and while rate hikes do have some effect on these, they could also generate additional headwinds for what looks like already decelerating levels of economic activity.
There is another important argument in favour of rate hikes as well. With inflation still surprising on the upside in advanced economies and their central banks pivoting to even more towards hawkish positons, rate hikes will become essential to compensate for the reversal in international capital flows for economies such as India, even if they come at the cost sacrificing some growth. Not doing this can increase difficulties on the external account. As these arguments show, there cannot be any perfect macroeconomic policy at the moment. The best the government can do is to mitigate the impact of its interventions on the most vulnerable sections of the economy. Alleviating any pain due to higher food prices should come at the top of the policy priority list, even if it puts additional pressure on the fiscal policy arm of the government.
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