Five months after the start of the war in Ukraine, the delicate inflation-growth dynamic is taking a turn. The slowdown in commodity prices should calm inflation, but not any time soon, and certainly not enough. Meanwhile, a recession is looming, posing a dilemma for central banks. Can the Reserve Bank of India (RBI) still be as aggressive as it planned to be when it meets next week?

As world commodity prices have fallen from the records of the first weeks of the war, Indian economists are indeed anticipating some relief from ultra-high inflation. It will be “a silver lining, especially if oil softens noticeably,” said Dhiraj Nim, an economist at ANZ Bank. Barclays economist Rahul Bajoria said in a July 12 report that if prolonged, the correction in global commodity prices, including edible oils, and base metals, “could have a moderating influence on headline inflation.

However, the reality is that most of these prices are on the verge of returning to pre-war levels, helped in part by the measures of the Center, and their pace still far exceeds pre-pandemic levels. Inflation is still expected to exceed 6% on average in 2022-23, and the RBI’s monetary policy committee would do well to continue to focus on rate hikes until inflation slows significantly, officials said. analysts.

Amid fears of a global recession, several international organizations and rating agencies have also downgraded India’s growth projections. The US Fed may be forced to react to fears of recession. However, from widespread inflationary risks to the margins of struggling businesses, there are plenty of reasons why economists believe the RBI should continue to focus on inflation as its primary target.

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Commodity prices

At all levels

A series of components of inflation will be on the radar of policy makers. The fuel depends on the progression of crude oil. After peaking at over $120/barrel this year, the commodity is down but still in triple digits. There are bearish views such as Citigroup, which expects it to be below $65 by the end of the year if a recession hits. But JPMorgan sees it around $104 if Russia cuts production in retaliation for sanctions.

Inflation in India would only drop to around 6.9% this fiscal year if oil moves closer to $100 a barrel, said ANZ Bank’s Nim, who otherwise expects an average of 7. 2% in 2022-23 on a higher crude oil price assumption. While the improving monsoon outlook provides a cushion on food, a bigger worry for the RBI could be demand-driven service inflation. “The sequential dynamics of services inflation remains a key thing to watch,” said Aditi Nayar, chief economist at ICRA Ratings. “That’s because strong domestic demand is likely to drive up prices.”

Divergent inflation

Also, for now, the cooling in commodity prices is likely to only be a balm for wholesale prices. This measure of price growth has been in double digits for over a year, and over 15% since April. Manufacturers in all industries have only recently raised prices to pass the pain on to consumers.

“We expect from WPI [wholesale price index] slow down over the next few months due to recent corrections in global commodity prices,” said Anubhuti Sahay, an economist at Standard Chartered Bank. “However, even if the WPI slows down, we believe that some repercussions [of high input prices] to consumers is [still] likely because growers have only partially overshot input price increases so far.”

Household expectations for inflation remain high, with nearly two-thirds of respondents surveyed by the RBI in May expecting inflation to be faster than the current rate over the next three months, and even more (71%) seeing it s worsen over a period of one year. This is the bleakest outlook for nearly a decade.

political dilemma

The RBI only jumped on the rate hike bandwagon in May, when inflation started to cross 7%. With inflation risks still present, how well placed is it to start tackling downside risks instead?

Inflation is accelerating in most countries

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Inflation is accelerating in most countries

Kunal Kundu, Indian economist at Societe Generale, said RBI might be better off sticking to rate hikes for at least a few more meetings. Bajoria said previous global or US recession cycles were accompanied by a commensurate decline in commodity prices, but on this occasion supply-side factors still exist. “The war will keep prices up even in a low growth environment,” he said. “That’s why it becomes more important for RBI to take this hit on the monetary policy side in terms of raising rates.”

While key commodity corrections provide some breathing room, existing volatility factors remain decisive as long as supply chains remain disrupted and a global economic meltdown looms. The RBI will closely monitor these developments.

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