RBI left with limited choices as retail inflation rises

The second Covid wave and location-specific lockdowns in major states have dislocated supply chains even in rural areas, which is going to manifest in rising prices of essentials, SBI Research has said in its latest report.

CPI inflation increased to 6.30% on yearly basis in May '21 as compared to 4.23% in Apr'21. This 200 bps increase on yearly terms and 100 bps increase in monthly terms is "a matter of concern", said SBI. "Even small items are showing disproportionately larger increases," it added.

It said rising food and commodity prices, as well as localised lockdowns, have led to a sharp increase in headline numbers. Core inflation has also increased to 6.55 per cent and the last time it was seen around this level was in Jun 2014.

Also read: Retail inflation spikes to 6.3%: What will RBI do now?

"We are now revising our CPI average for FY22 to 6.1 per cent and core inflation is likely to print at 6.4 per cent. Interestingly, latest core inflation is outside the mean plus 2*(standard deviation) if construct a bell curve using one year's data," the SBI Ecowrap report said.

Both core WPI and core CPI are positive and highly correlated. The relentless increase in global commodity prices will only imply that core CPI is unlikely to correct anytime soon. The SBI believes in the coming months, domestic inflation trends are likely to "raise anxiety levels in the RBI and the MPC" as inflation may remain elevated in the coming months.

It said repairing the supply chain remains the top priority on which the RBI has little control and that's where the Centre needs to step in a big way. "If the RBI has to ultimately increase interest rates or change its stance to combat inflation, it may impact any incipient signs of recovery. On the other hand, being a mute spectator can seriously impair the RBI's credibility in fighting inflation," the SBI report said.

Market research institutions and broking firms have expressed surprise over the sharp jump in India's retail inflation, a 6.3 per cent year-on-year increase, in May 2021. Analysts do not expect RBI to tweak the lending rates immediately to manage inflation though the rate exceeds the inflation target range set by the central bank.

SBI said the RBI could maintain a "status-quo" in terms of policy rates in August. "We believe RBI would still try to find a marriage of convenience of regulatory and developmental measures and monetary policy in August policy," the report said. SBI also said India must meaningfully vaccinate a large segment of the "rural population" in Q2 so that it can effectively beat the new mutant strain.

Also Read: Retail inflation rises to six-month high of 6.3% in May