Inflation control: Moderate success but miles to go to be within the target

Even though the central bank will have to weigh major macro-economic aspects and the evolving situation globally and domestically before deciding to start cutting the reference rate, it has also to be sure that the intended target of control on inflation has been achieved by bringing it within the target of four per cent on durable basis

The headline inflation, which has, of late, been a matter of concern for the whole world, has been on a cooling down mode. A reasonable control has been exercised on the inflation risk point of view, even though it has not achieved the targetted level. It is not clear if the time has come for cutting the reference rate and who will start this trend.

RBI’s latest bulletin says, " inflation has been abating, but at a slow stubborn pace and is likely to remain uncomfortably above targets in many countries for the third year in succession".

What are those risks to inflation? One is from the food price, while the other is from energy price shocks with uncertainty from climate change risks, the geo political situation and EL Nino conditions adding to the risks.

According to the report, the geo political risk is at a 14-month high at O.32 as of October, while the global supply chain pressure index (GSCPI) eased to (-) 1.7 in the same month. The global commodities prices recorded a broad decline with the Bloomberg Commodities Price Index falling by 0.2 per cent. Similarly crude prices softened, averaging $ 91.3 per barrel in October and further to $ 82.7 per barrel as on November 10, as compared to the $ 94 per barrel a month ago.

Meanwhile, inflation in advanced countries and emerging economies has shown a declining trend though the headline inflation is still above the target in most economies. For instance, in the US, the headline personal consumption expenditure (PCE) inflation remained steady at 3.4 per cent (Y-o-Y) in September with core PCE inflation moderating marginally to 3.7 per cent. The global market is eagerly awaiting and speculating as to when Fed Reserve will start cutting the reference rate.

In European Union, inflation fell to 2.9 per cent (Y-o-Y) in October from 4.3 per cent in September, which is its lowest level since July 2021. CPI inflation in the UK moderated to 4.6 per cent in October from 6.7 per cent a month before. Accordingly ECB decided to halt its tightening cycle for the first time in October and decided to keep the three key ECB interest rates unchanged.

Core and service inflation eased in recent months, although they remain much above the headline in most advanced economies. Service inflation of US in September was at 5.1 per cent, UK 6.6 per cent, EU at 4.6 per cent and Japan at 2.0 per cent and Core inflation as at the end of October 2023 stood at four per cent in the US, UK 5.7 per cent, EU 4.2 per cent and Japan at 2.6 per cent. These data gives an indication that inflation control is still continuing and there is no scope for comfort and central banks in these economies may not go for cut immediately and may continue to pause until they are sure of reaching their committed target of inflation.

It is worth recalling IMF’s recent Global Economic Outlook (October), where it is suggested that central banks should not get comfort with the short term victory in inflation control but should look for inflation control on durable basis.

In the case of emerging economies, headline inflation has been at different level as at October with Brazil at 4.8 per cent, Russia 6.7 per cent, China 0.2 per cent and India at 4.9 per cent. In the case of EMEs, central banks have resorted to divergent policy options. Indonesia and the Philippines raised their policy rates by 25 basis points each in October, after a series of pauses. Russia and Turkey hiked their policy rates by 200 bps and 500 bps, respectively. Sri Lanka, Brazil and Chile opted to reduce their policy rates by 100 bps, 50bps and 50 bps, respectively, while Peru and Poland reduced by 25 bps each.

In India, RBI has been following the pause as far as Repo rate is concerned and in its October meeting, the MPC unanimously decided to keep the repo rate unchanged at 6.5 per cent. RBI has been reiterating its focus on bringing inflation sustainably down as it targets four per cent.

The headline inflation CPI (Consumer Price Index) subsequently moderated to 4.9 per cent from five per cent in September.

Can this be considered favourable or is it too early to conclude so?

The RBI bulletin points out that the 15 bps softening in inflation came from a favourable base effect of 80 bps, which more than offset the positive price momentum of 65 bps during the month. All the three major groups recorded positive momentum with m-o-m increase of around 95 bps in food prices, 28 bps in fuel prices and 40 bps in the core group (excluding food and fuel). Food inflation (Y-o-Y) dipped to 6.2 per cent in October from 6.3 per cent in September. Core inflation moderated to 4.3 per cent in October from 4.5 per cent in September.

Even though the central bank will have to weigh major macro-economic aspects and the evolving situation globally and domestically before deciding to start cutting the reference rate, it has also to be sure that the intended target of control on inflation has been achieved by bringing it within the target of four per cent on durable basis. The bulletin says that a combination of monetary policy action and supply side interventions guided inflation down from the high it had climbed through the first seven months of 2022-23.

Hence, it is clearly brought out in the report that "we are not out of the woods yet and have miles to go".

It is only in 2024-25 that we can expect rate cutting from RBI and current pause situation may continue or if there is any variation in headline inflation due to volatility of food prices or energy prices, RBI may also take appropriate steps to mitigate those risks along with supply side measures by the government.

India has a favourable position as far as GDP growth is concerned at 6.5 per cent for 2023-24 or a surprise higher than 6.5 per cent, looking at the current trend of momentum and strong macro-economic fundamentals impart resilience in the face of global headwinds.

As for the GDP size, it is heartening to note that our GDP crossed the $4 trillion milestone on Sunday. According to a media report, India has made its way into the top four countries globally in terms of GDP. This is a landmark achievement and also marks the first significant step towards its $5 trillion economy goal.

(The author is former Chairman & Managing Director of Indian Overseas Bank)