Inflation remains a big worry ahead as country reels under Covid shock

Massive Urban spike foreseen, food price volatility may worsen as monsoon approaches; decade high wholesale inflation may put further pressure, but favourable base effect may have tempering effect

In what may turn out to be the third biggest worry for India, inflation across all segments may rise in coming months. The first two, obviously, are the public health crisis of Covid-19 and the loss of growth momentum due to the second wave. 

As the country began facing a second, and unprecedented, wave of Covid-19 in February 2021, the inflation ghost of 2020 has shown its head once again. Last year, a steep contraction in the economy was accompanied by a year-long period where inflation remained cosy with the upper comfort level of six per cent. 

Firstly, wholesale inflation has touched its decade high of 7.4 per cent in March, after remaining negative (deflation) in the crisis year of 2020. Secondly, consumer inflation has started rising once again after two months of cooling down due to weak food prices. Thirdly, core inflation is driving retail inflation up now, most of which is due to cost-push pressures, rather than rising demand. And finally, inflation is rising in cities, while it is relatively in the comfort zone in rural areas. 

The Monetary Policy Committee (MPC) of the Reserve Bank of India (RBI), which sets the benchmark for most interest rates in the economy, is likely to take a serious note of these developments in its June meeting. Available data leaves little room for further accommodation. 

The wholesale price index-based (WPI) inflation sharply rose to 7.39 per cent in March 2021, from 4.2 per cent in February, due to faster pick up in prices of metals, textiles, chemicals, rubber, etc. Higher taxes on fuels in March 2021—compared to March 2020, when taxes were low—also contributed majorly in higher wholesale inflation. 

Aditi Nayar, principal economist at Icra, said that depreciation in the rupee, which pushes up the landed cost of imports, will add to the inflationary pressures at the wholesale level in coming months. But there’s more to rising WPI inflation.

“There will be some transmission of higher wholesale commodity prices into the retail prices of manufactured items,” said Nayar. This means that consumer inflation may rise further soon.

Domestic market prices for steel have risen 40 per cent from July 2020 to March 2021, while China HR (hot rolled) FOB prices have risen 60 per cent in the same period. As steel is an important raw material in the automobile industry, car makers and vehicle manufacturers have hiked ex-showroom prices multiple times recently. Rise in steel prices also means rise in construction costs. 

Another interesting aspect of inflation on the rise, this time around, is that volatile food prices are not the reason. The fact that core inflation is printing above headline, or general, inflation, means that food and fuel components are not pushing inflation up. 

While core inflation for March stood at 6.1 per cent, general consumer inflation printed at 5.52 per cent, and food inflation remained at 4.94 per cent. 

Sreejith Balasubramanian, economist at IDFC Securities, said that most of the jump in core inflation is happening in services more than goods.

“Our inflation frameworks suggest the current landscape is one of rising price pressures from goods and, more recently, from services but these still seem quite concentrated, particularly for services,” he said in a note.

But he also said that some factors may act as a dampener on consumer inflation going forward. 

“Input cost pressures from higher commodity prices, of which crude oil price is the most important, could be passed on to consumers as manufacturers’ profit margins get squeezed. However, most of this price rise seems to be over and incrementally it could soften if demand weakens with a rise in Covid infections,” he said. 

As the economy braces for the second wave and renewed restrictions, it is already facing higher input prices. The degree of pass-through of higher input prices to already elevated core inflation remains a key indicator that needs to be monitored, ratings agency CRISIL said in a study.

In fact, the inflation in transport and communication stood at 12.5 per cent in March, highest since 2011. Other core components also showed a multi-month high, an India Ratings note showed. 

Household goods and services inflation stood at a 10-month high, recreation and amusement at nine-month high, and education at a four-month high. Health inflation has remained above 6 per cent since January 2021, it said. 

As most of these goods and services are more aggressively in urban areas, inflation in cities is rising faster than rural consumer inflation. 

Localised lockdowns and curfews have been reinstated in many parts of the country. Though they are less stringent than the nationwide lockdown of 2020, curfews have been more or less city-centric. In fact, a Business Standard report earlier this month noted that there are some states where lockdowns are “only urban,” but no states where lockdowns are “only rural”.

Faster rise in urban inflation, coupled with stoppage in economic activity may put the lives of city-dwellers under pressure in the form of lost incomes and higher prices. 

All these factors suggest that interest rates in the economy may not reduce further, and the low rates phase may be on its way out.

Even in the case of deep disruption due to Covid (as it happened in 2020), supply disruptions may result in an inflation spike, and that would limit the extent of the monetary policy support, Nayar of Icra said. 

Elevated global prices across commodities and higher transportation and logistics cost, price pressures are likely to prevail in the coming months for most segments, Care Ratings said in a note.