Over the past few weeks, the macroeconomic narrative seems to have suddenly changed. For more than 2 years since COVID first surfaced in India, the government and RBI narrative has been all about growth. With inflation soaring and the US taking a hawkish stance, the Indian government has changed its tune. To understand the extent of the inflation problem, just look at retail and wholesale inflation.
Food inflation (%)
Core inflation (%)
Headline CPI inflation
WPI Headline Inflation
|21st of August||3.11%||5.77%||5.30%||11.64%|
|21st of October||0.85%||6.06%||4.48%||13.83%|
Data source: MOSPI/Bloomberg
Wholesale manufacturing inflation has been at elevated levels throughout the year. But the real impact on components of retail inflation like food inflation and core inflation has been more pronounced since October 2021. That’s when a combination of fear of ‘Omicron, relentless inflation and the war in Ukraine drove prices up. It was almost Hobson’s choice for government. It was to curb inflation.
It started with rate hikes in May 2022
In a sense, the narrative changed with the special meeting of the Monetary Policy Committee (MPC) in May 2022. This was an unscheduled meeting to raise repo rates by 40 basis points to 4.40%. RBI let the markets know that from now on it would be inflation control at all costs. The logic was quite simple. The government and RBI had used most of the tricks up their sleeve to stimulate growth. To be fair, with the exception of contact-sensitive sectors, most other industrial and service sectors were already above pre-COVID levels.
This gave the first signal to the RBI to shift the focus from growth at all costs to inflation at all costs. The RBI had cut repo rates by 115bps as part of the COVID relief and that still leaves another 75bps for the COVID unwind. The Governor of RBI has already indicated that this is expected to happen in June and August. An anti-inflationary policy cannot be limited to rates and the cost of funds. RBI amplified the fight against inflation by increasing the CRR (cash reserve ratio) by 50 basis points to 4.50%. This will prevent liquidity to the extent of Rs87,000 crore and reduce credit creation for consumption and personal loans.
Control input costs
While the rise in the repo rate and the rise in the CRR would lower CPI inflation, its impact on supply-side inflation, as reflected by WPI inflation; would be limited. It has more to do with the supply of goods and services not keeping pace with demand. This is happening now in India and all over the world. The government has tackled the input cost syndrome on two fronts.
Firstly, the government made a massive reduction in excise duty of Rs8 per liter on petrol and Rs6 per liter on diesel. This reduced the selling price of petrol by Rs9.50 and diesel by Rs7 per litre. This represents a cost reduction of 7-9%. Gasoline, and especially diesel, have strong externalities. In that sense, not only do they impact fuel inflation, but the higher cost of fuel seeps into virtually every other element of the inflation basket. Therefore, the impact of the excise duty reduction will be cascading.
Second, the government has greatly reduced import duties on inputs. Steel has an impact on GDP by a factor of 1.2, due to its strong infrastructural component. Steel is used in the manufacture of automobiles, white goods, electrical equipment, construction and housing. The best way is to reduce the cost of steelmaking by granting tariff concessions on steel inputs. The government reduced import duties on ferronickel, coking coal and PCI coal from 2.5% to 0%, while import duties on coke and semi-coke were reduced from 5 % to 0%. The combined effect is likely to reduce the cost of steelmaking, which will be passed on to the user industries.
Increase domestic supply to lower prices
Reducing input costs is one way to curb cost inflation. The other way is to curb exports. Over the past two quarters, India has exported record amounts of steel, wheat and sugar. Exporters have had a good time with the rise in world prices, but it has also reduced the supply of these products in the domestic market. It was time to change policy.
- To discourage the export of iron ore and pellets, the government increased export duties on new iron ores and concentrates from 30% to 50%. Duties on pellets have been increased from 0% to 45%. This will ensure adequate supply of these metals internally, so that Indian steel users do not face supply constraints and higher input costs.
- Last week, the government also banned the export of wheat to ensure adequate food security in India. With global wheat supplies affected by the Russian-Ukrainian conflict, India’s wheat exports fell from $177 million in March 2022 to $473 million in April 2022. Globally, wheat prices wheat went from $325 per tonne to $450 per tonne. The government has partially relaxed this ban by allowing pre-contractual exports. The intent is quite clear; no exports to the detriment of domestic consumption.
- Now, the government plans to limit sugar exports, which had risen sharply in recent years. India’s sugar exports have increased 15-fold since 2017 thanks to rising sugar prices and a lucrative government subsidy program. For the 2021-22 sugar year (October to September), India has already exported 7.5 MT of sugar and could touch nearly 12 to 13 million tonnes at this strike rate. Now the government plans to limit sugar exports to 10 million tonnes this year to ensure greater domestic supply.
Rate hikes and CRR cuts will curb the end of consumer inflation, but will do little to curb WPI inflation. This problem is solved by a combination of reducing import tariffs and limiting exports through quotas and export duties. The government has started to tackle the cost impact of fuel, steel, wheat and sugar and will extend it to more commodities.
The good news is that these measures should reduce inflation by 100 to 150 basis points immediately. The bad news is that it could impact exports and lead to global retaliation. But it is a risk with which the Indian economy must live!