Just when the Indian economy was getting back on track after a jolt due to the Covid-19 pandemic, inflation has come to play spoilsport.
After cooling down for a few months, retail inflation in the country surged to a three-month high in February due to an increase in oil and food prices.
Higher inflation could force individuals to spend less, which will hurt overall consumption in the economy. Also, if the inflationary trends continue, India’s central bank will need to shift its focus from boosting growth to curtailing price rise.
So far, the Reserve Bank of India (RBI) has led the way in driving the Indian economy out of a technical recession by cutting the repo rate (the rate at which it lends to banks) to a record low and infusing liquidity through bond purchases.
But if inflation continues to go up, the RBI will be forced to raise the repo rate, which will lead banks to increase their lending rates and dissuade individuals and companies from borrowing.
“The RBI has a tough job on its hands to maintain the crucial balance between supporting the government’s fiscal policy through pumping adequate liquidity into the economy and reigning in the upward pressure on the rates if the economy overheats due to government borrowing and a mismatch between supply recovery and demand,” says Trishita Ray Barman, assistant professor at Shiv Nadar University.
Food prices in India increased by nearly 4% in the last month driven by oil and fat products and fruits.
What’s more worrying is the surge in oil prices. “If the recent rally in oil sustains, then the impact on inflation will be more pronounced over the next three quarters,” predicts Radhika Rao, an economist at DBS Group Research. Brent crude oil prices have risen 45% during the last six months.
Any rise in global crude prices has a direct impact on India as the country imports over 80% of its oil. Adding to the global surge in oil prices is the hefty tax levied by the Indian government to shore up the loss in revenue due to Covid-19 lockdowns. The Indian government has been raising taxes on oil since last year when the global crude oil prices were at an all-time low. And with the economic recovery still weak, the government is unlikely to give up the fuel tax anytime soon.