‘Revenge rebound in spending’ generalising price pressures: RBI paper

The paper, that analysed inflation trajectory in the country after February 2022, said that supply-side shocks resulting from the Russia-Ukraine war pushed retail inflation beyond the RBI’s upper tolerance level of 6 per cent.

India’s consumer price based inflation eased to an 11-month low of 5.88 per cent in November on an annual basis from 6.77 per cent in October, 2022. The decline can be attributed to easing food prices which account for almost 40 per cent of India’s CPI basket.

“The initial inflationary pressure was delivered by successive supply shocks but as their impact waned, a revenge rebound in spending and especially a swing from goods to contact-intensive services is generalising price pressures and making them persistent,” RBI paper titled ‘Anatomy of Inflation’s Ascent in India’ released on Tuesday said.

Authored by a team led by RBI Deputy Governor Michael Debabrata Patra, the paper said that with the worst of the pandemic’s two devastating waves having been weathered and unfavourable base effects being up to January 2022, RBI in February 2022 projected average inflation at 4.5 per cent during 2022-23.

The projection was on the basis of ebbing coronavirus infections, easing supply chain pressures, normal monsoons and global commodity prices moving in a range-bound manner.

“The precipitation of geopolitical tensions into an outbreak of war in Ukraine completely overturned macroeconomic conditions,” the paper, which is part of RBI Bulletin, said.
International prices of energy, industrial metals, and food shot up to unprecedented highs, and supply chain disruptions became acute, leading to an escalation of cost pressures.

Inflation reached multi-decade highs across advanced and emerging economies. The shock waves spilled over and inflation in India slipped its pre-pandemic moorings, levitating to a peak of 7.8 per cent in April 2022 before easing to an average of 6.8 per cent during May-November 2022, as per the paper.

This triggered accountability procedures mandated by legislation whenever inflation breaches the upper/lower tolerance bands around the target for three consecutive quarters, it said.

Last month, the RBI submitted a report to the central government detailing reasons for the failure to contain prices and remedial steps to rein in the price rise. This was the first time since the onset of the Monetary Policy Framework which came into effect in 2016 that the RBI was made to explain its actions in a report to the government.

The RBI left its inflation forecast for the country unchanged at 6.7% in its December policy, as it believed that the battle against inflation is still on and the core inflation remains sticky at an elevated level. As per RBI’s current projections, inflation is forecast to average 6.7 per cent in 2022-23 and 5.2 per cent in the first half of 2023-24.

“The foregoing analysis highlights the predominant role of supply-side shocks in pushing up headline inflation above the upper tolerance band. What started as a shock to food and fuel prices got increasingly generalised over ensuing months,” the paper said.

This was reflected in highly elevated and sticky core inflation.

“Unprecedented input cost pressures got translated to output prices, particularly goods prices, in spite of muted demand conditions and pricing power.

“As the direct effects of the conflict waned and international commodity prices softened, the strengthening domestic recovery and rising demand enabled pass-through of pent-up input costs, especially in services, adding persistence to elevated inflationary pressures,” it said.

Since early 2022, goods have been driving the inflation process. Services inflation lagged behind, especially on account of low house rent inflation and the low pricing power of services sector firms.

“As an explosive rebound in demand for services took hold subsequently, pricing power improved and translated into faster pass-through of high costs to services and the generalisation of inflation,” the paper said.

In India, the paper also said the prominence of food and fuel in the consumption basket amplifies the dominance of supply-side shocks and spillovers to the formation of overall inflation.

(With inputs from PTI)