MPC likely to hold policy rates as oil prices may spike inflation

Taking the economy out of a technical recession without stoking inflation is a major challenge in the preparation of the Budget for 2021-22, and some of the contours of this challenge, government officials say, will be set by the Reserve Bank of India’s (RBI) monetary policy decision on Friday.

The officials believe the committee may not immediately cut interest rates at a time when global oil prices are heading north. The RBI’s immediate priority is to tame inflation, they added. And growth has been better than expected, with GDP for the second quarter contracting only by 7.5%, bettering analyst estimates by a bit. A Bloomberg poll of 29 economists showed that no one expected a rate cut.

This means North Block may have to do more to drive growth, and hope that the inflation will fall within RBI’s comfort zone sometime early next year, opening up the possibility of a rate cut. India’s policy rate has been at 4% for the past seven months.

“There is a need to cut policy rates to boost the economy, which fell into a ‘technical recession’ with contraction in two consecutive quarters. But RBI may not opt for it because of two reasons—already high inflation and surging crude [oil] prices,” one of the officials said.

The Indian economy shrank 23.9% in the first quarter of 2020-21 mainly due a nationwide lockdown because of the Covid-19 pandemic, but saw a sharp improvement in the second quarter with a contraction of 7.5%. However, retail inflation continued its surge for the ninth month in a row to reach 7.61% in October, the highest since May 2014. It is well in excess of RBI’s comfort band of 4% plus or minus 2%

The officials said they do not see inflation softening immediately as global crude oil prices have jumped by over $7 a barrel in just one month and benchmark Brent crude touched $48.25 a barrel on Wednesday. A $10 per barrel increase in crude price adds about 49 basis points to inflation, they added. One basis point is a hundredth of a percentage point.

“India is the world’s third biggest importer of crude after the US and China. High oil prices have a direct bearing on transport fuels, particularly diesel, which has an inflationary impact,” a second official said. Due to a spike in global oil prices, pump prices of petrol in Delhi have risen by ₹1.60 per litre and diesel by ₹2.38 a litre in less than a fortnight.

“Currently, the oil cartel is deliberating their strategy to raise crude prices further by squeezing supply,” the second official said. He was referring to the Opec+, which is expected to continue existing output cut of 7.7 million barrels per day, about 8% of global supplies, in the first three months of 2021.

DK Srivastava, chief policy advisor at consulting firm EY India said a cost push CPI inflation would affect the next budget in three ways: designing a fiscally expansionary budget, reducing the tax burden on petroleum products; and higher food, fertiliser and petroleum subsidies since these are directly linked to petroleum prices.

The Union finance ministry declined to comment.

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