*Hobson’s choice for RBI: While the rate cycle needs to turn, recovery shouldn’t be a casualty | The Financial Express

Clipped from: https://www.financialexpress.com/opinion/hobsons-choice-for-rbi/2494333/

While the rate cycle needs to turn, recovery shouldn’t be a casualty The central bank has already said its top priority now would be to rein in the runaway rise in prices, and has upped its inflation forecast for the current year to 5.7%, a big increase over the 4.5% forecast earlier. Many economists have said this could be an under-estimate of the inflation trajectory.

Indeed, inflation, it would appear, will soon be entrenched across goods and services as companies pass on the additional costs of commodities to consumers and, in the farm sector, possibly through higher MSPs.Indeed, inflation, it would appear, will soon be entrenched across goods and services as companies pass on the additional costs of commodities to consumers and, in the farm sector, possibly through higher MSPs.

Given how retail inflation in March nudged 7% and was fairly widespread, RBI should move to tighten the policy rate. Action would be warranted not merely because the headline print is way above the top end of RBI’s target of 6%, but as Nomura India chief economits Sonal Varma has pointed out, nearly 70% of the sub-components of the consumer price index (weighted) are now rising above 4%, the mid-point of the tolerance band. Also, going by prices in April, especially of food items, it doesn’t seem there is going to be any respite soon. Indeed, inflation, it would appear, will soon be entrenched across goods and services as companies pass on the additional costs of commodities to consumers and, in the farm sector, possibly through higher MSPs.

The central bank has already said its top priority now would be to rein in the runaway rise in prices, and has upped its inflation forecast for the current year to 5.7%, a big increase over the 4.5% forecast earlier. Many economists have said this could be an under-estimate of the inflation trajectory. Moreover, RBI has moved to raise rates at the short end by 40 basis points, introducing the standing deposit facility (SDF) at 3.75%, and has shifted its stance to “focusing on the withdrawal of accommodation”. This stance should change to a ‘neutral’ in June, if not earlier.

The first of the hikes (of 25 bps) in the repo rate is expected in June, rather than August. Thereafter, economists are pencilling in three more raises of 25 bps, making for a cumulative 100 bps in the current fiscal. Should there be a de-escalation of geopolitical tensions and a sharp fall in crude oil prices fall, inflation might fall to levels lower than the current projections of 6.2% or thereabouts for FY23. To be sure, demand is picking up, especially for services.

However, a good part of the inflation is undoubtedly the result of supply shortages across a range of products, especially crude oil, the price of which remains elevated at close to $110 per barrel. As of now, local pump prices of petrol and diesel reflect a crude oil price of only $100 per barrel, leaving room for increases. The big worry is the jump in food inflation in March to 7.7% from 5.9% in February. Protein inflation is one reason the basket is becoming costlier, but edible oil and fruit have become much more expensive. Again, the increase in the cost of farm inputs could keep food costs high or push them higher. And as the economy opens up the pent-up demand for services could leave core inflation elevated. While it might seem difficult, the government must intervene to help RBI rein in inflation. Late last year, the Centre cut excise duties on auto fuels, giving up around `450 billion in revenues. A similar cut is called for from the Centre and states, especially on diesel, to arrest inflation, including food inflation. That would enable consumers to spend on other products. Also, if interest rates rise beyond a point, it will surely hurt recovery and especially small businesses already grappling with rising costs and shortages. RBI lowering its growth forecast for FY23 by as much as 60 bps to 7.2% is in itself worrying, but even this might be optimistic. Factory output remains anaemic—it grew 1.7% in February versus 1.5% in January—and the performance of the capital goods segment, in particular, has been very poor.

There is no doubt that RBI’s job has become quite challenging. The worry is that growth cannot move to a higher trajectory unless the private sector participates in investments. And for that, interest rates need to be affordable. The capex cycle is starting to turn and needs to be supported, as does consumer demand. Both require the cost of money to be moderate. That precisely is the central bank’s dilemma.

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