Mumbai: Inflation, based on the consumer price index, has risen consistently for the past seven months in India, reaching an eight-year high of 7.8% in April 2022. Persistent inflation is set to become the biggest headwind to India's post-Covid-19 pandemic economic recovery this fiscal year (FY), rating agency CRISIL has said. Meanwhile, investment banking firm and brokerage Morgan Stanley has said that the global economic slowdown, surging oil prices and weak domestic demand could lead to India's gross domestic product (GDP) growth coming down to 7.6% for FY 2022-23, and further to 6.7% for FY 2023-24. These figures, however, are from a much lower economic base due to the contraction wrought by the pandemic, therefore actual GDP growth will be lower than these figures suggest.

Inflation is affected considerably by food inflation, which is being driven by rising costs of production and international crop prices, and extreme weather-related disruptions. Prices are rising for consumers and cost of inputs are rising for manufacturers. How bad could inflation get and what will that mean for India? What does history tell us about how high inflation can be unwound? What can be done through monetary and fiscal policies to reduce prices and pressure on the economy? We asked Dharmakirti Joshi, chief economist at CRISIL.


Edited excerpts.

Inflation has been rising steadily, both internationally with the Russia-Ukraine war and rising crude oil prices, and also in India. Where is inflation headed?

Right now, the inflationary pressure is broad-based. If it were just a supply-side shock, for instance with oil prices, it could have been ignored, because that would have come down. But in India, the pressure is coming from food, fuel and also from core inflation which excludes food and fuel, so that becomes a worry for the Reserve Bank of India (RBI). If you compare the situation in the United States with India, in the US, demand is strong, the labour market is also tight, and there is a supply shock. In India, demand is weak, yet inflation is high and it's getting broad-based. Thus, it is a worry for both the government as well as for the RBI because of various factors. It hits the poorer the most, and it also creates economic instability. There's uncertainty about what's going to happen on the policy front to get it under control in the current milieu, where the risks and uncertainties are so high. This adds further pressure.

Supply-side pressures, with imported goods prices being high, is one aspect. Why is there weak domestic demand, which the Morgan Stanley report talks about as well?

Weak domestic demand reflects the K-shaped recovery in the economy. If you look at the GDP data that was published for 2021-22, the slowest growing component of demand is private consumption, which is close to 55% of GDP. I think the reason for that is the lower income brackets haven't benefited from the recovery as much, whereas the upper-income categories have not suffered at all during the Covid-19 pandemic, and their income might actually have risen. The broad basing of consumption demand happens when everybody consumes. Right now, consumption is biased towards high-income categories. For instance, if you look at automobiles, the luxury segment has done extremely well but small cars haven't done that well. If you look at cars versus motorcycles, the smaller ticket items haven't done well. That's a clear indication that there is a dichotomy in the system that's getting reflected in private consumption demand. Inflation is biting further because it reduces the purchasing ability of the poor.

How does India's situation contrast with what's happening in the rest of the world, either in similar-sized or larger economies?

In the USA, demand is not weak because they pumped in a huge fiscal stimulus. There was a supply shock and inflation turned out to be much higher than they expected, but even with high inflation, consumer demand hasn't gone down that much. That means the monetary policy will have to stamp harder to curb demand there.

In Europe, inflation is high largely because of energy [prices], unlike the USA where there are other domestic demand factors playing out. In Europe, the situation is a little different and so far consumer demand hasn't been hit to [a large] extent, but it is going to get hit.

In Asia, inflation has been a little slow to arrive, but now it is becoming a concern because the war seems to be prolonging and commodity and food prices don't seem to be coming down. There are supply bottlenecks coming from China, which worsen the situation further.

Thus the demand situation across the world, if you look at the summary indicator which is global growth, is slowing down, but at a different pace in different parts of the world. The components of demand which are slowing down also vary across the world, depending on local dynamics.

Food prices, weighted at 39% per your report, are one of the biggest movers of consumer price inflation and its most volatile component. Food inflation will be driven by rising costs of production, surging international crop prices and extreme weather-related disruptions. Tell us what high food prices and high food inflation means for different components of the population.

Food and energy prices, which are the key drivers of inflation right now, impact the bottom percentage more. For our estimates, we computed the impact [of rising inflation] across income categories and found that urban inflation is somewhat lower than rural, so the rural economy is suffering more because of inflation right now. Within each population category, the top 20% is facing lower inflation than the bottom 20%. So clearly, the impact across income categories varies. This is because the consumption basket varies across income categories. For the lower-income categories, energy and food are very critical. The upper-income categories consume more core items, which are goods and services.

How can high inflation be unwound? What could happen or what needs to change?

Global demand is slowing right now and because of that commodity and crude prices will also come down. The war and the Covid-19 lockdowns in China are most critical for supply-side bottlenecks right now. If the war ends quickly and the Covid situation in China eases faster, it will temper commodity and crude prices, which have actually already started easing a little bit in May compared to April, for instance. That demand slowdown will have a material impact on commodity and crude prices, particularly if these two bottlenecks get eased. That's something to be closely watched.

You talked about weak demand in India, which others have pointed out as well. How is that affected by these factors, or is it something else?

Weak demand also depends on inflation. Weak external demand means you will produce less for the external market and I think that also hurts us. There is a linkage. But the Indian weak demand story is playing out somewhat differently. For instance in 2022-23, I think people have learned to live with the Covid-19 virus. So this year, the key driver of demand will be contact-based services, which have been hit extremely hard by the pandemic, whereas goods consumption will not be that strong. Thus, they will tend to balance each other out, but the net result is continued weak demand as long as inflation is not tamed.

We've seen an interest rate hike but CRISIL is also saying that while there could be another 75 or 100 basis points [100 basis points equals 1%] increase, that will not really have an impact on inflation. So what, then, will impact prices?

Let's talk about monetary policy first, because the RBI is the goalkeeper for inflation. What they are doing is not going to bring down the price of food or fuel. That's very clear. But what it will do is slow down the transmission [of inflation] to other parts of the economy. So it will curb the generalisation of inflation to some extent. That is the role that monetary policy will play. And I think people will believe that the central bank is trying to control inflation so their expectations will also get somewhat anchored. I think that is the hope from monetary policy.

The bigger role in a supply shock comes from fiscal policy, which will have to do two things. One, it should try to reduce the extent of the supply shock, which is cutting excise duties on petroleum products, or reducing import duties on edible oils. All these things are going to help. But beyond this, fiscal policy will also have to take care of the vulnerable sections, which means more food subsidy going forward. Since input costs for farmers are rising, the fertiliser subsidy bill will also go up. So fiscal policy will have a much bigger role in controlling inflation, apart from the luck factors in global developments.

What's the timeline we need to be looking at for either reduction in import duties or further reduction in excise duties, particularly on petroleum, and for increasing food subsidies?

It will depend on how the scenario plays out. If there is news of easing of war, you can go slow [on duty cuts and subsidies]. But if there is further pressure, let's say crude oil goes up to $120-130 a barrel, then I think you will need another round of [duty cuts and subsidies]. As it's all data-driven, it's very difficult for me to point out when they should do it because I'm not sure how it's going to play out. It's a classic uncertain scenario. But my sense is that if inflation doesn't edge down, then it will have to be done sooner rather than later.

We do have a projected good monsoon and that may help. What's your larger sense of where we are as an economy today? Is India poised for better things? Have we fully recovered from the Covid-19 pandemic? Are we likely to go back to pre-Covid times?

The recent RBI study says that it will take a number of years to wipe out the permanent [pandemic-induced] loss to the economy. That is a given. The issue is how quickly you wipe it out, and that depends on how fast you grow. Let's talk about what is visible to us currently, for FY 2022-23. This year I think will be, as I pointed out earlier, a year of contact-based services. As we are able to move along with the virus, probably moving towards endemicity and better vaccination etc., services activity will support the economy. This is one sector which has not done well at all. It's still about 11% below the pre-pandemic level, so it will see a one-time bounce. That's going to play out this year.

Beyond services growth, the strength of the economic recovery will depend on how investments play out. If you dial back to the budget, the key driver for medium-term growth is government investments, particularly in infrastructure and the PLI [Production Linked Incentive] schemes. There are some good, positive moves on PLI schemes and I think that will push manufacturing investment up.

The government's infrastructure investment, however, is going to be key. The programme is very laudable, very extensive. But I think the point is that this year, the government was hoping to spend less on subsidies and more on capital expenditure [Ed.: generally investments in fixed assets/infrastructure]. Now I think they will have to spend more on subsidies. There's no doubt about it. Excise duty and import duty cuts also means a hit to revenues. So overall, I think there might be a short term blip there. Beyond that, however, the infrastructure investment which raises the potential of the economy is what will decide where you land going ahead. Agriculture is idiosyncratic, depending on the monsoons. In services, there is an inbuilt momentum that continues. Finally, I think what will also matter is how does this income dichotomy between the rich and the poor get sorted out as we move towards a higher growth trajectory. All these issues are very critical.

There are also some structural changes happening across the world so [we will need to see] how they impact us. I think there are too many moving parts right now, but we need to monitor each of them very, very carefully, and keep re-evaluating the potential and impact on the economy.

What's the red line figure when it comes to inflation, particularly food inflation, when it really begins to hurt? Right now, the eight-year high of 7.8% is overall consumer price inflation. What's the danger mark?

The defined danger mark is 6%. The RBI tolerance limit is 6%. So if I go by that, it's already above the danger mark and we need to act. That's why you will see front-loading of rate hikes by the RBI. And you might see some more fiscal action as we move ahead.

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