Price pressures strengthen the case for higher rates

In August, retail inflation, as measured by the consumer price index, rose to 4.8 per cent, up from 4.45 per cent in July, according to the National Statistics Office's latest data. Inflation pressures are evident across various categories, including food and non-food items. The food segment's inflation surged to 5.95 per cent, primarily due to the rising prices of items like onion, ginger, and garlic. Core inflation, excluding volatile food and fuel prices, also increased.

Inflation was observed in the personal care and miscellaneous goods and services sectors, with the hospitality sector experiencing price hikes due to higher food and fuel costs. Wholesale inflation reached 9.92 per cent in August, up from 9.78 per cent in July. These factors suggest that price pressures are becoming widespread.

Economists at SBI noted that data up to August indicates the start of inflation becoming generalized. Crisil's Deficient Rainfall Impact Parameter (DRIP) highlights a high vulnerability for crops such as cotton, bajra, maize, tur, groundnut, and soybean. Global energy prices have surged following the escalation in the West Asia crisis due to Houthi strikes on Saudi Arabia.

Brent crude oil is currently at $106 per barrel, while the Indian crude oil basket has risen to $128.7 per barrel as of September 14, up from $90.2 in August.

Higher fuel prices are expected to trickle into the broader economy. The RBI projects the Consumer Price Index (CPI) to reach 5.9 per cent in the third quarter of the year. Ratings agency ICRA anticipates inflation to stiffen to around 6 per cent during October-November, while SBI economists believe inflation could surpass the 6.5 per cent mark, surpassing the central bank's inflation targeting framework.

In August, the Monetary Policy Committee kept the repo rate unchanged at 5.25 per cent, maintaining a neutral stance. However, given its projections of inflation at 5.7 per cent for the second half of the year and 5.3 per cent in the next financial year's first quarter, real interest rates are mildly negative on a forward basis.

Broad-based price pressures and resilient growth suggest that a rate hike is warranted, despite the RBI's efforts to reduce excess liquidity in the system.