The coronavirus pandemic has pushed the Reserve Bank of India (RBI) into a corner. While the central bank has put growth as its overarching priority, inflation is getting ignored.

Much as the RBI would want to believe that inflation would soften after peaking in the fourth quarter of the current fiscal, it looks like the price pressures would continue if unaddressed. The longer it is allowed to run freely, the more likely it is to become entrenched for a longer period of time.

The Covid era, which forced governments to come out with stimulus packages, has shown that inflation is soaring in most parts of the world. This has become a matter of concern for not just the Federal Reserve and the Bank of England but also in the Euro region and elsewhere. For India to stay isolated outside this widening pool, it is too much of a hope away from the grim reality.

For the ninth consecutive time, the six-member monetary policy committee (MPC) has left unchanged the policy rate and its accommodative stance. The logic has been the same: that we need to use the growth pedal to support recovery from a butchered economy. While a part of that goal has been achieved with gross domestic product (GDP) slowly rising, inflation is continuing to hurt.

Inflation is visible in many, many things. Food, commodity prices, new vehicles…The list can go on.  Colliding with ultra-low interest rates, where fixed deposit rates have also sunk, the common man and the middle-class have been pinched hard both ways. The loss in jobs or salary cuts due to the Covid-19 pandemic has squeezed household incomes. No wonder then that private consumption is still below the pre-pandemic levels.

The RBI Governor Shaktikanta Das admits that inflation is a matter of concern. “The persistence of high core inflation (i.e., CPI inflation excluding food and fuel) since June 2020 is an area of policy concern in view of input cost pressures that could rapidly be transmitted to retail inflation as demand strengthens," he said in his policy address. “Price pressures may persist in the immediate term," he added.

The RBI, however, has stuck to its earlier inflation forecast of 5.3% for FY22 and even expects a lowering in the next fiscal. This is due to prospects of a good rabi crop and supply-side interventions by the government. “Over the rest of the year, inflation prints are likely to be somewhat higher as base effects turn adverse. However, it is expected that headline inflation will peak in Q4 of FY22 and soften thereafter,” Das said.

The common man’s worry is that inflation may rise higher than what the RBI has forecast. Even the RBI’s own survey shows that Indian households expect inflation to rise and remain in double digits. According to it, households’ median inflation perceptions for the current period increased by 20 basis points, reaching 10.4% in November 2021, while three months and one year ahead median inflation expectations increased by 150 and 170 basis points to 12.3% and 12.6% respectively, from the previous survey round.

Economists also see inflation sustaining at a higher level. “We do not see the inflation trajectory to be as benign and expect inflation prints to surprise on the upside and average at 5.6% for FY22, driven by elevated input and fuel costs and as the base effect wanes off. The risk of prolonged elevated core inflation feeding into household expectations and becoming more entrenched in the system remains,” said HDFC Bank chief economist Abheek Barua.

Global brokerage Nomura expects India’s inflation to rebound to 6% in early 2022, converging with elevated core inflation. “We expect higher prices of food, core commodities and services to lead to a convergence of headline and core inflation at ~6% over the next six months. We expect headline inflation to average 5.5% YoY in 2022, from 5% in 2021,” Nomura’s economists wrote in a note last month.

A couple of days after the RBI announced its bi-monthly policy, the US released its latest inflation figures that can have spillover effect on India if the Federal Reserve decides to tighten its monetary policy. The rate of inflation in the US hit a 39-year high of 6.8% in November, which is more than tripling the Federal Reserve’s 2% target. Caught between big social spending programme, strong consumer demand and pandemic-led supply-chain constraints, the world’s largest economy is witnessing its worst bout of inflation in decades.

India’s inflation also has shown tendencies of shooting up. In the previous fiscal, average inflation was 6.2%, which is above the RBI’s upper target band of 6%. Since then, it has softened but reigns much above the central bank’s lower target range of 4%. In November, retail inflation firmed up to 4.91% year-on-year due to a jump in vegetable prices. Fuel and vegetable prices could ease over the next few months but the bigger sustaining worry would be core inflation, which excludes more volatile energy and food prices. Core inflation in November stood at 6.1%  against 5.8% a month ago.

What could persist is high inflation due to rising input costs. These price rises have already come from a wide spectrum of sectors, including steel, cement, auto and electronics. Besides supply chain disruptions, there is fear of fresh restrictions from the new Omicron variant of coronavirus. Several economists believe that core inflation has steam to rise further.

Those who characterised the inflation as ‘transitory’ and a short-term consequence of supply-chain snarls have been proved wrong. The Fed chair Jerome Powell has admitted that high inflation has lasted longer than he expected. He is contemplating phasing out low-rate policies soon to tackle high inflation. Central banks across many parts of the world could go in for a similar tightening up.

The RBI was, in fact, preparing for a transition to monetary policy normalisation. In the previous policy announcement in October, Das had signaled that the RBI could start shifting from easy-money policy to a process of normalisation as the economy emerged from the shadow of the second wave of Covid-19. But Omicron came just ahead of the policy announcement in December and the draining out of excess liquidity in the banking system remains a measure more in intent.

For the RBI, growth concerns overshadow everything else. “Our overarching priority at this juncture is to broaden the growth impulses,” Das said. He emphasised on the need to provide continued policy support for a durable and broad-based recovery.

Since the RBI first cut the repo rate to 4% in May 2020, growth has returned. Not in any big way, but India’s GDP is moving forward. In the second quarter of the current fiscal, GDP grew at 8.4% but largely due to base effect. In the year-ago period, GDP had seen a decline of 7.4%.

But with inflationary headwinds strengthening across the world, growth in India can get messy as prices climb. Nomura believes that India’s current growth cycle is not durable and will peak by the first half of 2022. The RBI will be forced to act as higher inflation and wider current account deficit come into play. Recovery has been uneven, hurting consumption of lower-income households, and a sustained capital expenditure upcycle is also not in sight.

"Overall, we do not see the current growth cycle as durable. With mixed growth, high inflation and wider twin deficits, we expect India's risk premium to rise and the RBI to catch up as it falls behind the curve," Nomura analysts said.

The uneven way the economy is growing does not guarantee a broad-based revival of private consumption in the near term. The MSME (micro, small and medium enterprises) sector, which is the largest source of employment after agriculture and accounts for 30% of India’s GDP, is badly damaged. Wages in the unorganised sector are down while inflation is up. Private investment is improving but is moving more to capital-intensive areas and, thus, not creating too many jobs. High inflation in this situation can suppress consumer demand and impact growth.

The time is nearing when the RBI will need to give more attention to inflation. A new balancing between growth and inflation may be on the cards next year.