Time to take inflation seriously as ripple effect may maul the economy

The recent retail inflation spike has brought the macro concerns back on the policymaker’s radar. Diverse views have been expressed from various quarters in the government -- ranging from why in the first place should food inflation decide the policy rates; call for a policy rate cut; and that barring food price spikes, inflation is not a challenge. The last point was made by Department of Economic Affairs Secretary Ajay Seth at FICCI on Wednesday.

“We started the year with estimates in the Economic Survey of 6.5% to 7% growth, and I see that we are still very much within that zone. Additionally, I don’t foresee any significant downside risk. The numbers in the second quarter do show that some goods or services may not be at the same level where they were a year back,” said Seth, adding that food prices have been a problem area and that it is largely due to unusual rainfall, but other than the food prices, inflation is not a challenge.

Earlier this week, Finance Minister Nirmala Sitharaman, during an SBI event in Mumbai, called for a rate cut by the Reserve Bank of India (RBI) even as she mentioned the government is watchful of the emerging concerns of a slowdown. She called for the bank interest rates to be “far more affordable,” adding that this is one requirement if India aspires to become a Viksit Bharat (a developed economy).

Before that Commerce Minister Piyush Goyal had described the coupling of the food inflation and interest rates as an “absolutely flawed theory”, during an event in Mumbai on November 15. RBI Governor Shaktikanta Das responded by saying that he would like to reserve his comments till the next monetary policy scheduled to be announced in the first week of December.

The inflationary spike has ruffled some feathers in the policy-making wing of the government. And rightly so. It would be pertinent to recall over here that a retail inflation spike on the back of food inflation created a major rift between the Centre and the RBI during 2012-13 when the former was pressing for a rate cut to salvage economic growth, while the latter refused to budge. The then finance minister P Chidambaram and RBI governor D Subbarao locked horns publically with comments and counter comments.

A word of caution by RBI

Before taking the steep price spiral in a lighter vein, the North Block should note that food inflation has breached the 10% mark. In October this year, the food inflation rate stood at 10.87%. This will certainly have wide-ranging economic ramifications. The RBI has already cautioned. “Inflation is already biting into urban consumption demand and corporates’ earnings and capex. If allowed to run unchecked, it can undermine the prospects of the real economy, especially industry and exports,” said the RBI’s State of Economy report published yesterday.

Core inflation too is slowly emerging as a concern. “Core inflation rose 3.7% in October 2024, highest in ten months, led by higher inflation in housing, education and personal care and effects categories,” Motilal Oswal Financial Services said in its Ecoscope report.

Growth Concerns

High inflation will have a ripple impact on GDP growth as the much-awaited monetary easing will get delayed keeping the interest rates in a high zone, affecting private sector investments and capital spending. India’s growth projection has already witnessed a cut. Morgan Stanley has lowered India’s GDP growth forecast to 6.7% from earlier estimates of 7%.  Economic think tank, National Institute of Public Finance and Policy (NIPFP) has cut India’s GDP forecast for the current financial year to 6.9%-7.1% from an earlier estimate of 7.1% to 7.4%.

Dent on Consumption

High inflationary pressure has already started denting consumption in the economy. As is evident from the third quarter results, the subdued consumption on the back of high inflation has started gnawing at the corporate profits. Discretionary segments like the auto sector have taken a massive hit on the earnings in the second quarter of the current financial year and future guidance, with the prices tanking on the bourses. FMCG and consumer stocks, too, remained lacklustre on the back of poor quarterly shows. The corporate sector recorded net profit growth of 7.14% YoY in Q2 FY25 compared with 42.5% net profit growth YoY in Q2 FY24.

Currency Conundrum

Record outflows of Foreign Institutional Investors (FIIs) on account of tepid domestic corporate earnings and expected Trump rally in the US led to the rupee plunging to an all-time low of 84.38 on November 11. This prompted action from the government banks, most likely at the behest of the RBI. The banks sold dollars to rein in the falling rupee. The FIIs have dumped domestic equities worth ₹1.16 lakh crore in October and November to date.

In essence, the impact of inflation is wide-ranging. It is heartening to note that in addressing the slowdown concerns, the finance minister has already assured that the government is closely monitoring the situation. “I need to address the concerns arising from the recent signs of moderation in certain economic indicators. While I acknowledge the remarkable growth trajectory and the promising prospects of the Indian economy, it is also important to address the concerns. Let me assure you that the government is fully aware of the challenges posed by both domestic and global factors. There is no cause for undue concern. India’s economy remains resilient … Let me assure you all that the government is closely monitoring the evolving situation,” Sitharaman said.