Even as the Reserve Bank of India (RBI) surprised the markets earlier this month with an off-cycle move to raise its key policy rates and is set to raise it further in the upcoming monetary policy meeting, the report said. suggests that inflation will rise in time to moderate in India.
Retail inflation hit an almost 8-year high of 7.79 per cent in April, from 6.95 per cent in March. This increase was mainly due to a jump in vegetable and fuel prices.
Amid sustained inflation, the SBI report said it is now almost certain that the RBI will hike interest rates to pre-pandemic levels of 5.15 per cent in the upcoming June and August policy.
However, it expressed concern over whether such rate hikes would be effective in containing inflation if war-related disruptions continue.
imported inflation
SBI economists said they studied the impact of Russian aggression on inflation, which found that 59 per cent of the jump in prices was due to geopolitical events.
Using February as a base case, the report showed that due to the war alone, food and beverage, fuel, lighting and transport contributed a 52 percent increase, while another 7 percent impacted the FMCG sector. The jump came from a jump in input prices. ,
Rising food prices have emerged as a major concern for consumers – already hit hard during the two years of the pandemic – as prices of edible oil and vegetables rose amid fears of a fall in wheat production this year. developed.
Inflation in the food basket – which accounts for almost half of the CPI – rose to 8.38 per cent in April, from 7.68 per cent in the previous month and 1.96 per cent in the year-ago month, according to data released by National Statistics . Office (NSO) showed.
In the ‘oils and fats’ category, inflation remained as high as 17.28 per cent (18.79 per cent in March 2022) during the month, as Ukraine is one of the world’s leading sunflower oil producers and India imports a major chunk. of goods from a country devastated by the war.
In turn, high inflation, rising interest rates and dwindling forex reserves have pushed the Indian rupee to its lowest level against the US dollar.
Simply put, the rupee and inflation numbers are adversely affecting each other, and thus dragging the economy which was trying to recover from a 2-year pandemic slowdown.
A depreciating rupee means costly imports, rising costs of traveling abroad and studying abroad. Apart from the lack of supply due to the war, the falling exchange rate has made India’s crude oil imports more expensive. In the past too, the domestic prices of goods had jumped every time the rupee depreciated.
slight increase in salary
The report further noted that building wage pressures reflected in multi-decade high annual wage growth are fueling broad-based price pressures across all advanced economies.
This is the reason why it differentiated Indian inflation from other economies.
In India, marginal rural wages for both agricultural and non-farm laborers were raised during the second quarter of FY 2012. This was mainly due to the easing of restrictions by the states with the aim of resuming economic activities as the Covid cases remained under control.
However, reports said that the wage hike remained soft. Wage increases continue to be a weighted contribution to CPI build-up
minor.
Thus, even after the rate hike, inflation in India will take time to subside.
disproportionate effect of inflation
Stating that inflation is unlikely to recover anytime soon, the note noted that there is a difference between rural and urban areas when it comes to price hikes.
The former are more affected by the pressures of higher food prices, while the latter are showing greater impact due to hike in fuel prices.
For rural areas, CPI inflation in food and beverages stood at 65 per cent, compared to 52 per cent in urban areas. Vegetable prices contributed the most in both the categories.
Even spices and fuel and lighting were more expensive in rural areas than in urban areas.
On the other hand, the cost of transportation, clothing, milk and grain were higher in urban areas.
inflation and growth
From October 1, 2019, all banks, including SBI, were mandated to lend only at an interest rate linked to an external benchmark, such as the RBI’s repo rate or treasury bill yield. As a result, transmission of monetary policy by banks has gained traction.
Banks take funds from RBI at this repo rate. When RBI increases the policy rate, it becomes costly for banks to get money from the central bank. This, in turn, forces them to raise their lending rates as well.
Therefore, retail loans that are benchmarked to the external rate with a quarterly reset clause can grow directly with the increase in the repo rate, hence 100 per cent transmission.
As of December 2021, 39.2 per cent of loans were the benchmark for external rates – mostly repo. This will lead to higher interest costs for consumers, impacting demand, the report said.
On the other hand, the report said that depositors benefit in such scenarios as there can be equally fast transmission.
It noted that the large proportion of public deposits in total liabilities for countries like India has had significant implications for macro stability and policy transmission.
First, with banks funding themselves through retail deposits, the source of vulnerability to external infections is significantly reduced.
Second, only 1 per cent of bank lending is currently at the policy rate of 4.4 per cent.
Thus, in the earlier regime, when the repo rate was increased by 25 bps even under full transmission, there was a maximum 15-basis point effect on deposit rates (25 bp * 59 per cent interest sensitive fixed deposits) and thus lending. could have been done. rates.
Whereas now, 25 bps will be transmitted directly in the lending rates, which may affect the borrowers.