Government goes after inflation; all guns blazing

25 May 2022 , 10:48 AM

In the last few weeks, the macroeconomic narrative appears to have suddenly changed. For over 2 years since COVID first surfaced in India, the narrative of the government and the RBI was centred around Growth. With inflation rising sharply and the US taking a hawkish stance, the Indian government has shifted narrative. To understand the magnitude of the inflation problem, one has to only look at retail and wholesale inflation.

Month	Food Inflation (%)	Core Inflation (%)	CPI Headline Inflation	WPI Headline Inflation
Apr-21	1.96%	5.38%	4.29%	10.74%
May-21	5.01%	6.40%	6.30%	13.11%
Jun-21	5.15%	6.11%	6.26%	12.07%
Jul-21	3.96%	5.93%	5.59%	11.57%
Aug-21	3.11%	5.77%	5.30%	11.64%
Sep-21	0.68%	5.76%	4.35%	11.80%
Oct-21	0.85%	6.06%	4.48%	13.83%
Nov-21	1.87%	6.08%	4.91%	14.87%
Dec-21	4.05%	6.02%	5.59%	14.27%
Jan-22	5.43%	6.21%	6.01%	13.68%
Feb-22	5.85%	6.22%	6.07%	13.11%
Mar-22	7.68%	6.53%	6.95%	14.55%
Apr-22	8.38%	7.24%	7.79%	15.08%

Data Source: MOSPI / Bloomberg

The wholesale producer inflation has been at elevated levels through the year. But the real impact on the retail inflation components like food inflation and core inflation were more pronounced since October 2021. That is when a combination of the Omicron scare, the relentless inflation and the Ukraine war hoisted prices. It was almost a Hobson’s choice for the government. It had to curb inflation.

It began with rate hikes in May 2022

In a sense, the narrative shifted with the special meeting of the Monetary Policy Committee (MPC) in May 2022. It was an unscheduled meeting to raise the repo rates by 40 bps to 4.40%. RBI sounded out to the markets that from here on, it would be inflation control at all costs. The logic was quite straightforward. The government and RBI had used most of the tricks in their bag to boost growth. To be fair, barring 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 focus from growth at all costs to inflation at any cost. The RBI had cut repo rates by 115 basis points as part of COVID relief and that still leaves 75 bps more for COVID unwinding. RBI governor has already indicated that it should happen in June and August. An anti-inflation policy cannot be only about rates and cost of funds. RBI amplified the fight against inflation by hiking CRR (cash reserve ratio) by 50 bps to 4.50%. This will pre-empt liquidity to the extent of Rs87,000 crore and reduce credit creation for consumption and personal lending.

Clamping down on input costs

While the repo rate hike and the CRR hike would bring down the CPI inflation, its impact on supply side inflation as reflected by the WPI inflation; would be limited. That has to do more with the supply of goods and services not keeping pace with demand. That is happening currently in India and across the world. The government has attacked the input cost syndrome on two fronts.

Firstly, the government effected a massive excise duty cut of Rs8 per litre on petrol and Rs6 per litre on diesel. This has reduced the selling price of petrol by Rs9.50 and diesel by Rs7 per litre. That is a cost reduction of 7% to 9%. Petrol, and especially diesel, have strong externalities. In that sense, they not only impact fuel inflation but the higher cost of fuel virtually seeps into all other items in the inflation basket. Hence the impact of the excise duty cut will be cascading.

Secondly, the government aggressively cut the import duties on inputs. Steel has a GDP impact of 1.2 factor, due to its strong infrastructure component. Steel goes into the manufacture of automobiles, white goods, electrical equipment and construction and housing. The best way is to reduce the cost of manufacturing steel by giving duty concessions on steel inputs. Government cut import duty on ferronickel, coking coal and PCI coal from 2.5% to 0% while the import duty on coke and semi-coke were cut from 5% to 0%. The combined effect is likely to reduce the cost of making steel, which will be passed on to user industries.

Increasing domestic supply to bring down prices

Cutting input costs is one way of curbing cost inflation. The other way is to curb exports. In the last couple of quarters, India has been exporting record quantities of steel, wheat and sugar. The exporters have had a field day amidst rising global prices, but that has also curtailed supply of these commodities domestically. It was time for a policy reversal.

• To discourage the export of iron ore and pellets, government increased the export duties on new iron ores and concentrates from 30% to 50%. Duties on pellets were hiked from 0% to 45%. This will ensure adequate supply of these metals internally, so that Indian steel users don’t 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 impacted by the Russia / Ukraine conflict, India’s wheat exports had shot up from $177 million in March 2022 and $473 million in April 2022. Globally, wheat prices had gone up from $325/tonne to $450/tonne. The government has partially relaxed this ban by allowing pre-contracted exports. The intent is quite clear; no exports at the cost of domestic consumption.
• Now, government plans to limit sugar exports, which had surged sharply in the last few years. India’s sugar exports grew 15-fold since 2017 on the back of higher sugar prices and a lucrative government subsidy program. For the Sugar Year 2021-22 (October to September), India has already exported 7.5 MT of sugar and may touch close to 12-13 million tonnes at this strike rate. Now government is planning to restrict sugar exports to 10 million tonnes in this year to ensure more domestic supply.

Gist of the inflation control story

The rate hikes and CRR cuts will curb the consumption end of inflation but do little to curb WPI inflation. That is being addressed through a mix of import tariff reduction and by limiting exports through quotas and outbound duties.  The government has begun attacking the cost impact of fuel, steel, wheat and sugar and will extend it to more commodities.

The good news is that these moves are likely to reduce inflation by 100-150 basis points immediately. The bad news is that it could impact exports and could invite global retaliation. But that is a risk that the Indian economy has to live with!