Why inflation has become systemic

Retail inflation has been over 6% for nine consecutive months or three quarters starting January. This implies that the Reserve Bank of India (RBI) has failed to meet its inflation target as retail inflation has remained above 6% for three consecutive quarters.

One ideology that prevails is that inflation is largely driven by food and fuel prices, and therefore, the RBI does little to control inflation by raising the repo rate, the interest rate at which it lends to banks. does not make.

Food inflation stood at 8.6% in September, with grain prices rising by 11.5% from a year ago. Food prices have increased by 7.8% from April to September. Therefore, higher food prices have pushed up the overall retail inflation.

Inflation in fuel and light products stood at 10.4% in September. This includes items like domestic cooking gas, kerosene (both subsidized and non-subsidised), coal, firewood and chips, whose prices have gone up in the last one year.

This does not include the prices of petrol and diesel, which have not been inflationary despite being over the last three months. Diesel prices for vehicles declined by 1.9% in September compared to last year.

Clearly, food and fuel items are adding to retail inflation. Does this mean that RBI cannot do anything to control inflation? This interpretation would be incorrect as core inflation, which is inflation of commodities excluding petrol, diesel and other fuels for food, fuel, light goods and vehicles, has remained high over the years. Key inflation items make up a little over half of the index.

Core inflation was 6.5% in September. It has been over 5.5% in 14 out of the last 16 months and over 6% in six of the last seven months.

Clearly, while core inflation has not been as high as inflation in food and fuel items, it has also played a role in raising the overall rate of retail inflation.

One possible explanation may lie in high inflation which has turned into wage inflation as people demand higher wages to compensate for higher prices. Thus, inflation has become systemic.

Given that core inflation is high and rising, it makes sense for the central bank to raise the repo rate. The central bank started raising the repo rate in May and has so far raised it by 190 basis points to 5.9%. A basis point is one hundredth of a percentage.

The motive behind increasing the repo rate is to curb the demand for bank credit. Also, higher interest on deposits encourages people to save money and, in the process, defer consumption.

This makes it less money to chase goods and services and rein in consumer demand, although this dynamic takes time to play out.

Non-food credit growth stood at 15.7% as of September 23, the fastest since January 2014, despite a 190 basis points increase in the repo rate by the RBI since May. Banks mainly give loans to Food Corporation of India and other state procurement agencies. Buy rice and wheat directly from farmers. Once these loans are deducted from the overall bank credit, the non-food credit remains. Clearly, raising interest rates by the RBI has so far not controlled credit growth. However, at the same time deposit growth remains weak. This means there is a further hike in the repo rate and is expected to help control retail inflation.