Crude rally may tie RBI’s hands on rate hikes

The Centre may not cut excise duties and rather prefer consumers and oil firms share the burden of higher prices

MUMBAI : The unbridled surge in commodity prices has left the Reserve Bank of India (RBI) in a dilemma as it looks to strike the difficult balancing act between stanching inflationary pressures and supporting the nascent recovery in the economy after the covid crisis.

Soaring prices are a big setback to RBI’s expectations that inflation would ease this year even as it clouds India’s fragile economic recovery.

Without an early resolution of the Russia-Ukraine conflict, the future course of monetary policy will depend on the quantum of pass-through of higher crude oil prices the government will eventually allow to retail prices, economists said. Higher retail fuel prices will have a cascading effect on the prices of goods and services.

It is estimated that a 10% rise in pump prices or retail fuel prices could lead to a direct impact of 20-25 basis points (bps) on inflation measured by the Consumer Price Index (CPI). Brent crude prices touched $130 a barrel on Monday, reflecting global uncertainties over oil supply after Russia’s aggression. While higher crude prices are set to upset the government’s fiscal math and the monetary policy committee’s (MPC) inflation forecast, economists said interest rates are unlikely to change in the near term. “Globally, central banks tend to pause during periods of uncertainty to assess medium-term impact on growth and other macro variables,” said Saugata Bhattacharya, chief economist, Axis Bank.

The minutes of the rate-setting panel’s February meeting underlined a nagging worry about the durability and spread of the economic recovery, and experts still see multiple reasons that may lead to a further slowdown in economic activity and aggregate demand.

“Considering the signals from the last few policy meetings, given the current risks to sustained recovery, MPC might tilt towards growth instead of inflation. Hence, rates are likely to be on hold in the next policy review, even if inflation is then assessed to breach the 6% upper band,” Bhattacharya said.

In January, retail inflation stood at 6.01%, above the MPC’s flexible target. According to the monetary policy framework, the MPC has to maintain CPI inflation in the 2% to 6% range, with the median target of 4%.

Economists believe while the MPC would wait out the April policy, if the current crisis continues and higher crude prices get passed on to pump prices, RBI may need to revise the 4.5% inflation forecast. That said, RBI’s rate panel is also unlikely to ignore inflation over a prolonged period, particularly if there are signs of higher input costs being transmitted to end-consumer prices and inflation starts getting embedded in expectations.

“The unabated rise in crude prices is creating a serious policy dilemma for RBI and government,” said Soumya Kanti Ghosh, group chief economic adviser, State Bank of India.

Ghosh said on the part of RBI, it is most advisable to look through the current rise as an outlier and continue to focus on growth. He believes some support may come from the fiscal front, with the government providing a cushion to consumers by not increasing fuel prices for now.

 “We must appreciate that a solution to the ongoing conflict as and when it comes through will have a significant upside to the markets. It’s best to ride out the storm now and wait for sunny days,” he said.

Not everyone is hopeful of the government’s benevolence, and some believe a fuel price hike is imminent. However, oil prices have not risen since the last retail price hike in November, and the state-run fuel retailers are bearing the cost. “My sense is that this week, pump prices for petrol would rise by ₹10-15 per litre and diesel by ₹5-7 per litre, passing on some of this extra cost to consumers. It is a tightrope walk for the government,” said Madan Sabnavis, chief economist, Bank of Baroda.

The Centre may not cut excise duties and rather prefer consumers and oil firms share the burden of higher prices, he said, adding states also seem unlikely to make any revision to their value-added taxes on fuel.



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