Almost 59% of inflation since February is due to war related factors, according to a study by SBI economists. But there are concerns amidst this backdrop about whether rate hikes by the central bank will be useful in taming inflation forcing the central bank to go for more aggressive rate hikes during the year.
Using February as the base case when the Ukraine and Russia conflict began, the SBI economists study reveals that Food and Beverages (assuming that vegetable price increase was mostly because of seasonal factors, that are largely domestic) and Fuel and Light & Transport contributed 52% of the increase in overall inflation since February because of the war. ” If we also add the impact of input costs particularly on the FMCG sector, thus adding the contribution of personal care and effects, the total impact at all India level comes to 59%, purely because of war” said S K Ghosh, group chief economic advisor at State Bank of India.
Consumer price index (CPI) inflation has crossed way beyond the mandated upper band of 2-6 per cent. Headline CPI inflation touched 6.95 per cent in March forcing the monetary policy to review rates on May 4, and raise benchmark policy repo rates by 40 bps ( one bps is 0.01%) to 4.4% ahead of its scheduled meeting in June.
Subsequently the April CPI inflation touched an eight year high at 7.79%. “However, the important challenge facing the central bank remains whether inflation will tread down meaningfully because of such rate hikes if war related disruptions do not subside quickly” said Ghosh.
Even in these circumstances where addressing supply side issues play a bigger role in addressing inflation, even demand and inflation expectations can be managed by central banks, say some economists. ” Rate hike will slow the build-up of excess demand. Cannot affect war factors” said Madan Sabnavis chief economist, Bank of Baroda. “But if rates rise and credit slows demand for say cement and steel is curbed which lowers inflation. Companies won’t invest unless demand is there. Hence this part of inflation curbed. This holds everywhere in the world. As the economy slows demand slows and prices curbed”.
The Russia-Ukraine conflict is not showing any signs of abating that could put further pressure on CPI inflation. “The Russia-Ukraine conflict is not showing any signs of cooling down. In fact, on the margin, the geopolitical environment seems to have deteriorated amidst unrelenting posturing by the two sides. This has raised the pressure on commodity prices further” said a report by ratings firm Acuite Ratings and Research.
Economists expect the RBI to restore repo rates to the pre-pandemic level of 5.15 per cent by August it-self. If inflation continues to remain high, there could be over 100 bps rate hikes this fiscal in addition to a hike in cash reserve ratio or CRR.
“A higher interest rate will be also positive for the financial system as risks will get repriced” Ghosh said.