In the US and other western countries, demand has been high, because of the liberal stimulus announced by governments to ward off the impact of Covid. In India, the tardy government policies were not configured to trigger consumer spending.

But, with the WPI rate in India, which reflects the prices of key industrial and agricultural commodities, raging at 13 per cent on an average in the past six months, this raises fears of a rise in the CPI, as producers will have to raise prices to recover higher input costs in coming months. While this will lower the inflation gap between the US and India, it will bring misery to the common man.

India Inc feeling brunt

Inflationary pressures are already hurting big companies. Take the case of Coal India. Global coal prices have been on the higher side, which has led to greater demand for dry fuel from domestic sources. Recently, Pramod Agrawal, chairman of the coal mining major, flagged an urgent need for a price hike of the dry fuel, contending that without which, “certain subsidiaries” would find it “difficult to survive”.

In an effort to tide over inflationary pressure, the miner is expected to raise prices after the assembly elections in five states, including Uttar Pradesh, in March. “Every day is critical for me. A price hike has become urgent. For certain subsidiaries, survival depends on it,” the Coal India boss is understood to have told investors on Thursday.

In a revealing article for The Economic Times, Devina Mehra, CMD, First Global, recently underlined the worries for India Inc, as well as for investors, inherent in the high levels of wholesale inflation. “So, we have a situation where producers are facing the highest inflation in two decades, which is not reflecting in consumer prices and that has implications for us not just as consumers but also investors.”

Simply put, companies are facing cost increases that they are unable to pass on to end consumers to the extent they would like, because of dull consumer demand. This has translated into margin pressures that are already visible across the board in Q3 2021-22, in diverse industries from FMCG to autos and chemicals to capital goods.

In fact, according to Mehra, operating profit margins for a sample of 432 companies (excluding banks and financials) contracted 200 basis points year-on-year (y-o-y) as raw materials costs jumped 466 basis points y-o-y. For instance, BHEL’s gross margins were down 100 bps y-o-y, hit by higher commodity prices on nearly 50 per cent of fixed price-based order backlog.

Marico’s consolidated gross margins fell 320 bps. JSW Steel’s EBIDTA margin contracted nearly 500 bps y-o-y, though net sales were up 50 per cent y-o-y. Bajaj Auto’s EBIDTA margin, for instance, contracted 420 basis points y-o-y, driving down the EBIDTA by 21 per cent y-o-y. This trend will only accelerate in the current quarter and beyond.

The Ukraine factor

There is another factor that Modi and his ministers are glossing over – or at least not yet pressing the panic button about. The trouble brewing on the Russia-Ukraine border has sent oil prices shooting, fuelling global inflation, which in the long run could feed into domestic inflation in India. As it is, inflation is fast becoming a threat in the global macroeconomic theatre.

“Rising International crude oil prices remain a huge threat, accentuating inflationary pressures, even though fuel inflation eased in January to 9.32 per cent from 10.95 per cent in December,” said M. Govinda Rao, chief economic advisor, Brickwork Ratings. “The ongoing Ukraine crisis is likely to escalate the international crude oil prices higher, hence the central government may have to lower the excise duties in the coming months to control inflation,” Rao, a member of the 14th Finance Commission, said. Indeed, the government’s stance on retail fuel prices after the ongoing assembly polls – to raise them or pare excise duties – will be critical in determining the inflation trajectory from March. 

Even if retail inflation were to slide back to the 5 per cent range in February and March on the back of suppressed fuel prices, the critical moment will be in March after the elections conclude as there can be a fresh round of increase in fuel prices, he emphasised. Even if retail inflation peaks in the current quarter, ICRA chief economist Aditi Nayar says it may not moderate quickly. Nayar now expects a change in the monetary policy stance only in June 2022, followed by two repo rate hikes of 25 basis points each in August and October. “This is guided by our view that inflation will not moderate appreciably in the first half of 2022-23,” she notes. 

The possibility of Russia actually invading Ukraine and such an act blowing up into a full blown war between Russia and the members of the North Atlantic Treaty Organization (NATO) will have serious repercussions for India, especially its economy. Though the possibility is now receding as Russia is now pulling back some of its forces from near Ukraine, it would ultimately depend on how conclusively the US and its NATO allies deal with Russian objection to the potential inclusion of Ukraine in the military alliance. A lot would depend on how the inscrutable Vladmir Putin plays his next poker hand.

Last fortnight, the price of oil has been above $90 a barrel. Russia is the world’s second largest producer of both oil and natural gas and global oil supplies. And this crisis comes at a time when the world energy market is already struggling to keep up with demand. JPMorgan has warned that any disruption to Russia’s oil flows would send oil to $120 a barrel. 

Oil is key

Oil could send our economic calculations into a tizzy. This year’s Economic Survey expects crude petroleum prices to be in the range of $70-75 per barrel over the course of fiscal year 2022-23. Assuming that oil prices will average this much in the next financial year, India will achieve a real GDP growth of 8-8.5 per cent.

Sabnavis calculates that a 10 per cent increase in crude oil would push up WPI by 0.9-1 per cent and Consumer Price Index (CPI) by 0.4 per cent to 0.6 per cent, while current account deficit (CAD) is likely to increase by 0.4 per cent of GDP. This will have a negative impact on the rupee. “Higher crude prices will mean higher revenue for the states under unchanged excise duty conditions. With crude prices going up the subsidy on LPG and kerosene will increase, though this may not be significant.”

An RBI paper from January also warns that if a crude price shock hits the Indian economy, the CAD to GDP ratio will rise sharply irrespective of a higher GDP growth. A $10/barrel increase in oil price will raise the inflation by roughly 49 basis points or increase the fiscal deficit by 43 bps as a percentage of GDP if the government decides to absorb the entire oil price shock rather than passing it to the end users.

Economists have warned that rising oil and food prices pose a risk to inflation. But RBI governor Shaktikanta Das has said the central bank’s retail inflation outlook for 2022-23 was quite ‘robust’. The RBI has projected average retail inflation of 4.5 per cent in 2022-23. It is forecasting inflation to subside to 4.2 per cent by Q4 in 2022-23.

Das has reiterated that inflation momentum was on a downward slope since and the central bank had taken into account all scenarios. “When you do inflation projection, you assume a crude price for the whole year, a particular price and a range of prices. If you take $95 a barrel and make a projection for the entire year you will definitely go wrong. It may go up further and come down steeply,” says Das.

RBI’s logic off-the-mark?

The Monetary Policy Committee (MPC) of the RBI has opted to keep the repo rate and the reverse repo rate unchanged for the 10th time in a row at 4 per cent, signalling that it will “continue with an accommodative stance as long as necessary to revive and sustain growth on a durable basis”, to mitigate the damage caused by the pandemic.

The MPC’s decision has divided economists and financial experts into two camps. While one is supportive of the decision given that India’s consumption levels are still to take off meaningfully, the other is criticising it on grounds that the central bank will be forced to revisit its inflation projection considering the rapidly spiralling out-of-control commodity prices.

Indeed, it may not be as simple as Das thinks. Consumers have been enjoying stable petrol and diesel prices for more than three months now. The artificial respite from rising fuel prices has been necessitated by the current round of assembly elections. The price freeze has dampened inflationary pressures artificially to an extent. But the respite – and even the substantive politically-influenced rollback in several states – may not last long and is likely to make way for a steep increase after the last phase of assembly elections in Uttar Pradesh on 7 March.

Oil companies waiting

Some market experts expect the increase to be as high as R8 per litre for petrol and diesel as global crude oil prices have risen by almost $14 per barrel since 4 November – the last time retailers in India changed domestic prices – and oil companies need to make up for the losses so far. According to estimates, a $1- increase in global crude prices results in a 45-paise increase in the domestic prices of petrol and diesel. The actual burden can be marginalised by lowering the duty component but this will impact the exchequer.

The fuel price hike (along with that of coal) would lead to un-bottling of inflationary pressures which have been kept on hold because of assembly elections, unless the Central and state governments once again have the stomach for a cut in taxes on petrol and diesel. 

Oil companies in India are legally free to align their prices with global rates, after the complete deregulation of fuel prices in 2014 – but, fearing public backlash, they usually have to freeze prices in the run-up to elections. On 3 November, in order to cool retail prices from record highs, the Modi government made a steep cut in excise duty on petrol and diesel, by Rs5 and Rs10 respectively. This was followed by a cut in value-added tax in many states and Union territories to give further relief to consumers.

The Organisation of the Petroleum Exporting Countries (OPEC), which largely holds the supply of crude to India, said last week that world oil demand might rise even more steeply this year, as the global economy posts a strong recovery. Mukesh Kumar Surana, chairman & managing director, Hindustan Petroleum Corporation, claimed at a public event last month that state-owned fuel retailers have not been raising prices, as global prices are extremely volatile, and price revisions in such a scenario would be counterproductive to the purpose of daily price changes.

“There is sensitivity to prices,” added Surana. “Therefore, when prices are elevated, there are concerns, and so we are ensuring the least inconvenience to consumers”. He went on to add that fuel retailers are trying to keep prices aligned ‘over a period’ rather than aligning on a daily basis for the time being.

The government was hoping that crude oil prices will come down over the next few months; so, it won’t be forced to cut excise duties to rein in inflation when oil companies pass on higher costs to customers. Given that the budget has not made any provision for a cut in excise duties in case crude prices remain persistently high, both the RBI and the government will find themselves in a tricky situation if the Ukraine crisis does not settle down and, more importantly, crude prices doesn't come down. 

Modi and inflation

So far, Modi had tamed price rise; will he be equally successful now?

Controlling inflation has been one of the strong points of Modi government’s performance so far. Finance Minister Nirmala Sitharaman has been harping on this achievement whenever she gets an opportunity, mostly when she has to rebut criticism of her government’s economic management, as does Prime Minister Narendra Modi.

Replying to a general discussion on the Union Budget in Parliament recently, Sitharaman had said that the Indian economy suffered the biggest contraction due to Covid-19 pandemic, but the government has been able to contain retail inflation at 6.2 per cent. Comparing it to the performance of the UPA government during the global financial crisis in 2008-09, she pointed out that retail inflation was 9.1 per cent then. Besides, the pandemic had a bigger impact on the economy than the financial crisis. At Rs9.57 lakh crore, the Indian economy suffered the biggest contraction, because of the pandemic, compared to a loss of Rs2.12 lakh crore during the global meltdown in 2008-09.

Modi himself recently told Parliament with a measure of pride that during 2014-20, the inflation rate was below 5 per cent. Taking a jibe at the Congress party, PM said: “The Opposition has raised the issue of inflation here; it would’ve been better if they had raised that matter while their government was in power.”

Inheriting inflation

In May 2014, when Modi took over as prime minister, inflation, as measured by the consumer price index (CPI), stood at 7.72 per cent, with food inflation at 9.21 per cent. In February 2019, the end of his first term, inflation was at 2.57 per cent, with food prices falling by 0.66 per cent. During 2018-19, food prices rose by just 0.13 per cent. It is a different thing that, on the flip side, the lack of food inflation was hurting farmers.

The tight grip which the Modi dispensation had maintained over price rise began slipping, with the onset of the first wave of the pandemic. Now, there are fears that things are not so comfortable and both the government and the Reserve Bank of India are underplaying the threat of brewing inflation.

P. Chidambaram, former FM, one of the foremost critics of the Modi dispensation, has for some time been attacking the Centre for ‘pretending’ that price rise is a ‘false concern’. Along with the high rate of unemployment, “inflation has broken the back of the people, and we hold the Central government under Narendra Modi directly responsible for the high inflation,” he says. He has been demanding a reduction in fuel prices and GST rates, and a review of the import duties to reduce the “crushing burden of high inflation.”

Excise duty cut

Last year, in November, as rising petrol and diesel prices led to a public outcry, the government effected an excise duty cut of Rs5 on petrol and Rs10 on diesel to offset the impact of rising crude oil prices. While this will lead to a revenue loss of Rs45,000 crore (0.2 per cent of gross domestic product or GDP), in the remaining months of 2021-22, the cut was aimed at translating to about 0.14 percentage point (pp) reduction in headline inflation in November due to direct effects, and about 0.3 pp, including the second round impacts, as logistics costs decline. 

The government had then come to the conclusion that, while inflation was statistically less than 5 per cent then, high fuel cost was hitting consumption. Besides, assembly elections in five states, in which the BJP had a key stake, were round the corner. To some observers, it appeared to be a case of political jitters.

Was the cut enough? The outcome of the assembly elections could be an indicator of how successful the government’s strategy to tackle price rise has been.

Inflation targeting

It wasn’t like that earlier. Last year, the government, in the midst of fighting the second wave of the pandemic, had decided to retain India’s inflation target at 4 per cent, with a band of 2 per cent on either side for another five-year period, ending March 2026. Most economists had welcomed the decision, as in the then uncertain economic scenario, retaining the inflation target provided stability and helped the Reserve Bank of India’s Monetary Policy Committee focus on anchoring inflation expectations, while also balancing the objective of supporting growth.

Earlier, in 2016, India adopted a flexible inflation targeting framework in 2016. The RBI Act 1934, amended through the Finance Act of 2016, established a modern monetary framework with a clear objective of achieving price stability, while keeping in mind the objective of growth. A six-member MPC, with three internal and three external members, was set up to determine the policy rate to achieve the inflation target. The Consumer Price Index-based inflation target was set by the government at 4 per cent, with a tolerance band of plus/ minus 2 per cent for the period from August 2016 to March 2021.

 Steady course

As the pandemic disrupted economic activity, there was a debate about revising the inflation target to allow the central bank greater leeway to cut interest rates and focus on growth in the pandemic-struck economy. In addition to revising the target, many commentators suggested modifying the inflation targeting framework. There were calls to abandon it.

The Economic Survey argued for changing the inflation metric from headline inflation to core inflation, and thus excluding food and fuel prices which are transitory and mainly supply side factors that monetary policy cannot influence. However, the RBI has, through various publications, argued for retaining the inflation target at 4 per cent, with a 2 per cent band. The government also felt there was no need for a trade-off between growth and inflation – a strategy followed to some extent by Congress FMs like Pranab Mukherjee and Chidambaram.

The Modi government’s faith in robust inflation management stems from the BJP’s political assessment that it was the runaway inflation in the years leading to the 2014 general election that cooked the Congress-led UPA government’s goose. In fact, inflation had reached an all-time high of 12.17 per cent in November 2013. An average retail inflation rate of 10.4 per cent across the five years of UPA 2 government had led to sharp anti-incumbency when the elections were held. In fact, UPA 1 had also handed over a high inflation rate of more than 8 per cent to its second variant.

The Modi government, while managing inflation well, however, could not accelerate the economic growth rate much. GDP growth rates were higher during the UPA’s tenure. Under the new series, GDP grew at 8.1 per cent in the UPA decade (2004-14), while the average under Modi’s first term comes to 7.3 per cent. The gap could have been narrower, if three disruptions had not happened – two years of consecutive bad monsoon in 2014-15 and 2015-16, demonetisation and the goods & services tax (GST).