Commodity conundrum | Business Standard Editorials

Clipped from: https://www.business-standard.com/article/opinion/commodity-conundrum-121051301342_1.html

Higher international prices will increase policy risks

A decline in the inflation rate and a surge in the index of industrial production (IIP) would please markets and policymakers alike in normal circumstances. But economic indicators warrant careful interpretation in extraordinary times such as these. The latest data shows that the retail inflation rate moderated to 4.3 per cent in April, while industrial production in March went up by 22.4 per cent. Both the IIP and inflation numbers were impacted by a favourable base. Growth in industrial production will moderate in the coming months as the base effect of last year’s stringent lockdown fades. However, inflation outcomes would be influenced by a variety of factors. Both the government and the Reserve Bank of India (RBI) will need to be watchful to keep the pace of price rise within the tolerance limits.

The inflation rate moderated largely because of a higher base and sharp decline in vegetable prices. But there are limits to which vegetable prices can decline. Further, in the food component, edible oil prices have increased sharply. Besides, core inflation remains a concern. Economists note that core inflation is showing strong sequential momentum. Restrictions on public mobility and the spread of Covid-19 in almost every part of the country are affecting supply chains, which would put upward pressure on prices. Inflation outcomes in India will also be influenced by global factors. Global commodity prices have risen sharply and are expected to remain elevated. Iron ore prices, for example, have grown three-fold in a year. The Economist commodity-price index in dollar terms has gone up by over 80 per cent in the past one year. The index for metals has doubled, while food prices have also increased sharply.

There are a number of reasons for this sharp increase in commodity prices. Global prices are rising on the back of stronger than expected recovery in some advanced economies, particularly the US. In fact, the latest inflation reading at 4.2 per cent in the US surprised most analysts and resulted in a sharp selloff in the stock market. The US economy is recovering strongly with more and more people getting vaccinated. With increasing mobility, consumers are expected to spend more, including forced savings, which are expected to push up both demand and prices. Moreover, it is likely that easy money is finding its way to commodity markets, along with stock markets, which is pushing up prices. Experts expect commodity prices to remain elevated, partly because of the expected nature of economic recovery. Several countries, including the US, are expected to spend significantly on infrastructure to revive growth, which will increase demand for commodities.

However, the US Federal Reserve believes that higher prices are transitory. It has also moved to an average inflation-targeting framework. Consequently, instead of acting preemptively, the Fed will allow the inflation rate to remain above the target of 2 per cent for a while. But in an uncertain environment, this could result in higher inflation for longer than desired. To be sure, global inflation conditions wo­u­ld increase policy difficulties in India. Higher global inflation could push up pric­es in India at a time when the level of economic activity has slipped considerably. Capital outflows could also tighten financial conditions prematurely. Thus, both the government and the central bank would need to be vigilant. The Union governm­e­nt would need to work with states to minimise supply chain disruptions. Mea­n­while, the RBI will need to assure markets that it would maintain price stability.

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