Persistence of retail inflation may cause a rise in interest rates

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According to the domestic rating agency, the growing threat of stagflation for the Indian economy and the persistence of retail inflation above 6 percent may lead to a rise in interest rates. The sudden rise on inflation within the short term has already led the Monetary Policy Committee (MPC) to carry the interest rates in August and has also decreased the likelihood of a longer rate cut within the near term, Acute Ratings and Research said.

Due to the corona virus pandemic, the risks of stagflation have increased significantly in the Indian economy that leads to slow down the effectiveness of monetary and financial measures adopted by the financial institutions and government. Stagflation implies a painful phase of high inflation but low or negative growth leads to aggravating the challenges faced by the Indian policymakers. As per the report, immediate steps got to be taken to bring down food inflation, the upper levels of which have already begun to spill over to core inflation. India’s consumer inflation has increased to 6.93 percent in July 2020, a sharp and unexpected rise of 70 basis points (bps) over that in June.

 From December 2019, the consumer price index (CPI) print has been on overdrive and has been uncomfortably high over 6 percent, the upper limit set by the MPC. Even though an unfavorable base effect is also playing a crucial role in shaping inflation trend line and food inflation. It has been the important driver of the CPI trajectory and since October 2019, it has mostly hovered over 8 percent over the last nine months.

The supply and logistical bottlenecks arising from the lengthy and irregular lock downs in certain parts of the country have continued to stay food inflation high despite appropriate agricultural output over the last two seasons. Further, the report said that persisting high food inflation including with shortage of labour has begun to have a high effect on prices of non-food products and services or core inflation, which has risen by 50 bps to 5.6 percent in July from 5.1 percent in June and 4.1 percent in July 2019.

 Go through by the MPC’s mandate on inflation targets, RBI may need to remove its accommodative stance and adopt a decent monetary policy if the inflationary pressures don’t subside over the near term, it cautioned. The consequent reversal of lower interest rates will raise capital costs and impact the outlook towards new investments, complicating the expansion and therefore the unemployment rate will be increased. The report says that monetary stimulus programmes will have a limited impact in reviving growth in such an environment and targeted fiscal measures got to be considered to tug up private consumption because the pandemic situation eases out over the coming few months.

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