The rising trend in inflation rate based on consumer prices continues in March 2022 too, as the latest inflation readings from India and US stays above the target rate set by their respective central banks. The consumer price inflation was 8.50 percent in US and 6.95 percent in India for the month of March 2022. The RBI target rate for CPI inflation is 4 percent within a +/-2 percent band. The corresponding figure for US is 2 percent.
This is the third consecutive month during which CPI inflation in India stayed above RBI’s target range. RBI in its latest MPC meeting held earlier in April has acknowledged the risk of high inflation and indicated its intention to change its accommodative stance so that inflation remains within the target range.
Inflation rises typically because of two reasons. Either there is high demand in the economy and the current supply or production in the country is not able to meet this demand, or there is some disruption in supply that reduces available supply creating demand-supply mismatch resulting in price rise. The first is called demand-side inflation and the later one supply-side inflation. The inflation we encounter now has a mix of both.
The Indian economy has revived considerably and is on a strong footing after the disruptions caused by the covid-19 pandemic. The quarterly GDP grew 8.4 percent and 5.4 percent for the quarter ended Sep 2021 and Dec 2021, respectively, and is estimated to grow at 8.9 percent for the full-year 2021-22. Several high-frequency indicators – railway freight, GST collections, export-import, electricity demand, fuel consumption – points to robust growth in the economy. This might be causing demand-side inflation, which is good in a way, because it validates the presence of strong demand in the economy. In such situations, RBI (or central banks, in general) typically increases interest rates, so that inflation remains within the comfort zone, which helps to sustain and prolong the economic expansion.
There are supply-side issues, too, that might be contributing to the present high inflation. The shortage of semiconductors used in automobiles has disrupted automobile production for close to a year. The western sanctions on Russia in response to Russia’s invasion of Ukraine has virtually taken Russian crude oil out of global markets, which has resulted in prices rising above $100 per barrel, the highest in 14 years. Unlike demand-side inflation, there isn’t much central banks can do to counter inflation emanating from the supply-side.
To sustain the nascent economic recovery evident from the latest GDP figures and high-frequency indicators, it is imperative to find solutions to resolve the supply-side issues contributing to the high inflation.
India depends on imports for its semiconductor needs. The construction and commissioning of a semiconductor plant takes close to 10 – 12 years, so turning indigenous is not a solution to the present shortage problem. The Indian government has boldly taken steps to purchase Russian oil at discounted rates, but will it be able to bring fuel costs down at the consumer level is something we have to wait and see.
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