From UPSC perspective, the following things are important :
Prelims level : Not much.
Mains level : Paper 3- Rising inflation-slowing growth rates and its consequences for Indian economy.
High inflation has reduced the fiscal space available for a rate cut.
RBI target of 6% breached.
- CPI at 7.35 %: Retail inflation, as measured by the consumer price index (CPI), has surged to 7.35 per cent in December 2019.
- Latest inflation data seems to corroborate fears articulated by the Monetary Policy Committee (MPC) in its December meeting.
- In the meeting, MPC refrained from cutting the benchmark repo rate.
Consequences for the economy
- Reduced scope for fiscal slippage: High inflation reduced the space for further easing of policy rates.
- Even after clarity over the extent of the Centre’s fiscal slippage emerged.
- Rise in yield for 10-year securities: The 10-year G-sec yields have reacted sharply to these developments, rising to 6.67 on Tuesday.
- Offsetting operation twist: Rise in yield resulted in offsetting the impact of the RBI’s recent open market operations.
- Inflation targeting under stress: The combination of weak economic activity and higher than expected supply-side inflationary pressures has put the inflation-targeting regime under test.
Reasons for the inflation rise and chances of easing
- Food prices rise: Much of the rise in the headline inflation number can be traced to higher food prices.
- Food inflation has risen to a near six-year high of 14.12 per cent in December 2019, up from 10.01 per cent in the previous month.
- Vegetable prices have surged to 60.5 per cent in December, contributing nearly 3.7 percentage points to the headline numbers.
- Chances of ease in coming months: While vegetable crop cycles tend to be short, and supply-side pressures may ease in the coming months.
- The stickiness in prices of protein items is likely to provide a floor for food inflation.
Bleak outlook for inflation easing
- No short-term return to normal level: Food inflation is unlikely to revert to previous levels in the short term.
- Household inflation expectations, a key metric in the MPC’s assessment, are more responsive to food inflation, this will further exert upward pressure on MPC.
- A factor of hostilities in the Middle East: The uncertainty over oil prices on account of hostilities in the Middle East, adds to the bleak outlook for inflation.
With limited fiscal space for a meaningful stimulus, the government intends to support the economy during this rough patch, and return growth to a higher trajectory.