Deep dive into major components of inflation- food, fuel and core- each reveal idiosyncratic factors that will potentially be longer lived.
By Rajni Thakur
The word “transitory” is increasingly part of the inflation narrative, both in India and globally. Inflation all-around has been higher than expected and running at a faster pace than in the last few decades. But the key Central Banks have described it as transitory because they are mainly driven by one-off factors. They expect elevated price increases on back of one-off factors which are not sustainable. The current list of one-off factors is however, extremely long and varied. As such, ‘transitory’ inflation in no way implies a brief or short-lived period of price rise.
In India, annual retail inflation rate rose higher than the prescribed target for RBI in May again this year. Wholesale price inflation is also running higher than it has been for almost three decades. Last year inflation was out of the tolerance zone for two quarters and most analysts have maintained that high inflation will be ‘transitory’. Yet, persistently high inflation has assumed a permanence throughout the year.
And still RBI communications show that inflationary concerns don’t figure on their priority list for now. Like major central banks, RBI has consistently communicated that they are willing to look through any transitory inflation till ‘durable recovery’ returns. The MPC minutes reveal that the members of the MPC seem to believe that their duty is to support growth recovery from the pandemic and “focus on revival and sustenance of growth is the most desirable policy option while of course remaining watchful of the inflation trajectory.” As a key policy maker, RBI understandably needs to support growth and hence is possibly buying time to respond to inflation till economic momentum is strong. This however does not qualify for the transitory inflation narrative.
Deep dive into major components of inflation- food, fuel and core- each reveal idiosyncratic factors that will potentially be longer lived. Food inflation for example, has been driven by volatile vegetable prices and persistently high prices of proteins and perishables (meat, eggs, pulses, fruits etc). Food prices can very well reduce as supply conditions normalise. But they play a crucial role in forming inflation expectations and thereby end up influencing the headline inflation numbers by driving up wages and costs, which are sticky.
Imported prices — largely fuel or commodities prices — are almost an external given price for India. If the latest rise in domestic prices is largely cost push for producers and commodity-driven, then it could prove to be less transitory than believed. The sharper the global recovery, the longer the sustenance of commodities boom. Going by the 2009 economic rebound trends, demand for raw materials and their prices soared for two years and pushed up global inflation until commodity markets topped out.
The real transitory part is the very temporary inflation from a set of quirks related to the economy’s reopening impacting core prices. Supply chains are complex, and they have come under pressure during the pandemic, as companies are faced with challenges including raw material shortages, rising input prices and longer delivery times. This unusual dynamic could also last much beyond next few months and will only reduce when the manufacturing costs come down.
RBI apparently believes that it will only need to worry about entrenched inflation when demand returns. But it may well pose the biggest threat to the current nascent economic recovery. It’s premature to conclude all of this is transitory and where underlying inflation is ultimately going to land when we get through the price normalizations. There is a real possibility that RBI might be discounting the danger of inflation because of the context of the pandemic. Particularly, at a time when the government is also running massive fiscal deficits and many central banks worldwide are beginning to consider how to pause or pare their accommodative stances.
(Rajni Thakur is the Chief Economist at RBL Bank. Views expressed are the author’s own.)