Calming inflation: Negotiating the knife-edge

The conflict in Europe has pushed up international commodity prices, including crude oil.

inflation, economy
The pass-through effect of reduced input costs to the retail segment has reduced consumer inflation. (IE)

By Saikat Sarkar and Harish Kumar Kallega

The year 2022 was marked by a return of high inflation worldwide after three to four decades. Although advanced nations, in general, have an annual inflation target of 2.0%, they are still grappling with much higher inflation rates. The UK and Germany are still experiencing high inflation at 9.2% and 8.6%, respectively, while US inflation reached its 40-year high at 9.1% in June 2022. The inflation rate in the US has declined since then.

After the Covid-19 pandemic receded, extraneous domestic and global factors fuelled inflation in India. In 2022, the main spike was seen in April, when retail inflation climbed to 7.8%, riding mainly on the back of two commodity groups — food and fuel.

Food inflation can be attributed to excessive heat in summer and uneven rainfall in some parts of the country that affected the farm sector, reducing supply and causing prices of major products to soar. Inflation in the vegetable segment was caused by a surge in tomato prices from April to September 2022 owing to crop damage and supply disruption due to the unseasonal rains in the major producing states. Edible oils got dearer because of imported inflation. India meets 60% of its edible oils demand through imports. The Russia-Ukraine conflict exacerbated the shortfall in global edible oil production, causing a rise in edible oil prices in India.

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The conflict in Europe has pushed up international commodity prices, including crude oil. The global rise in prices of items like petroleum products, basic metals, and chemical products — sensitive to international price movements — translated into worsening domestic inflation.

The surge in global commodity prices was initially evident in wholesale price inflation, and its lagged impact was perceived in consumer price inflation. Developed economies hiked interest rates to contain inflation, and as the US Federal Reserve raised rates, the US dollar appreciated, making dollar-denominated fuel imports even costlier.

However, when the major Western countries were grappling with the geo-political tension and stimulus package-induced inflation, the Indian government and the central bank succeeded in reining the rise in the inflation rate. The country has followed a multipronged approach to rein in inflation. First, to bring down food inflation, the government has followed steps like the rationalisation of tariffs and the imposition of stock limits on edible oils and oil seeds. The buffer stock system has been maintained for price stability in pulses and onions. Second, import duties on raw materials (steel, plastic products, cotton, chemicals, diamonds and gemstones) used in manufactured products have been rationalised to reduce input price pressures on Indian manufacturers. Third, a cut in central excise duty on petrol and diesel in November 2021 and May 2022 led to a moderation of the retail-selling price of petrol and diesel in India. Further, global economic slowdown and interest rate increases brought down commodity prices, contributing to a substantial decline in wholesale price inflation.

The pass-through effect of reduced input costs to the retail segment has reduced consumer inflation. Lastly, RBI went ahead and decisively raised repo rates in successive meetings — from 4% to 6.25% between May and December 2022.

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However, the RBI forecasts higher domestic prices for cereals and spices in the near term owing to supply shortages. Increasingly unstable climatic conditions may further raise the inflation risk. A lot depends on easing industrial input prices, and its delayed pass-through to consumer prices may contribute to the stickiness of core inflation. It is also influenced by geopolitical disturbances; the attendant imported inflation, the soft landing of the US economy, and China’s return from normalcy from the Covid-19 pandemic. However, considering the overall risks to the benign baseline view on inflation, continued vigilance on the inflation front is the best expedient for the coming financial year.

(Sarkar is Economic Adviser and Kallega, Deputy Director, at the Department of Economic Affairs in the Finance Ministry)

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First published on: 01-02-2023 at 02:40 IST