The problem is inflation’s second-round effects

Inflation's second-round effects have emerged as a significant challenge for the Reserve Bank of India. During its October monetary policy, the Monetary Policy Committee (MPC) adopted a hawkish stance, raising interest rates and signaling a calibrated tightening of policy. However, two members of the committee voted against this shift, arguing that inflation was driven largely by supply-side factors and not showing signs of overheating or generalization throughout the economy.

MPC member Nagesh Kumar believed that inflation was not widespread and did not pose a threat to the economy. On the other hand, committee member Saugata Bhattacharya cautioned that data indicated price pressures were becoming entrenched in the economic system. RBI Governor Sanjay Malhotra echoed this concern, noting that 37% of commodities in the Consumer Price Index (CPI) basket had inflation above 4% in August, compared to just 20% in March.

RBI's household inflation expectation surveys show that three-month-ahead inflation expectations have jumped 70 basis points to 9.9%. These rising price pressures could further intensify, particularly as global food prices harden and El Niño strengthens, potentially impacting India's rabi crops. While the central bank has only observed limited signs of supply-side pressures being embedded in pricing behavior, the extent of future policy tightening will depend on how the committee assesses supply-side pressures, the emergence of second-round effects, and the evolving dynamics between growth and inflation.