It has been a difficult week for India in terms of handling inflation. During the week, the retail CPI inflation and the wholesale WPI inflation came in higher than expected. What does this mean?
Unravelling the CPI number
The Reuters consensus estimate was for CPI inflation to taper in Feb-22 from 6.01% to 5.93%. Instead, CPI inflation came in higher at 6.07%. The surge in oil price was one factor, but there were 2 other critical factors too. Firstly, the food inflation was higher over previous month by nearly 45 basis points. Also, the core inflation came in close to 6.2%, hinting at pressure on other items like clothing, footwear, housing, health etc.
WPI was a bigger issue
The spill over in the case of wholesale inflation was much bigger. According to the Reuters estimates, the WPI inflation was supposed to fall sequentially from 12.96% to as low as 12.15%. Instead, the WPI inflation for Feb-22 came in sharply higher at 13.11%. Needless to say, the biggest pressure on the WPI inflation came from fuel inflation which is due to crude rallying sharply by about 25% in one month. In addition, Feb-22 also saw a sharp increase in other key inputs like minerals and chemicals. Indian companies are likely to see a very sharp spike in cost of inputs in the March 2022 quarter, putting further pressure on operating margins in Q4.
Reliving the US experience
In a way, the macro situation in India is similar to that in the US. In both the economies, there has been a rebound in GDP growth. The unemployment levels have come down sharply; albeit not yet back to pre-COVID levels. In both, India and the US, the supply of products and services have failed to keep pace with the demand resulting in supply chain constraints. As a result, both the US and India are seeing runaway inflation with the US consumer inflation at 40-year highs of 7.9%. The one difference is that the US has admitted that inflation is not transitory, while India continues to hold the view that inflation will vanish.
Time for RBI reality check
Till the Feb-22 RBI policy, it was all about what the US Fed was expected to do. In Mar-22, the US Fed hiked rates by 25 bps and has guided for 6 more rate hikes in 2022. Even the UK has put through 3 rate hikes already. The risk of monetary divergence is that the yield gap between Indian debt and US debt could narrow sharply and this can have 2 implications. Firstly, it can lead to debt outflows, of the kind we saw in 2013. The other, equally serious possibility is of a sharp weakening of the INR. Quite often, both these effects tend to feed on each other. The bottom line is that the RBI is running out of choices. In Apr-22, RBI will have to drop its accommodative stance and start hiking interest rates.