‘Economic headwinds might emerge from higher inflationary prospects’

New Delhi: Headwinds for India’s economy might emerge due to higher inflation prospects, EY India said.

According to the latest ‘EY Economy Watch’ report, persistently high domestic fuel prices on account of steadily rising global crude prices has stroked inflationary pressure.

Lately, recovery in global crude prices has been driven by a pick-up in demand as well as supply side factors.

“These developments have a significant bearing on prices of petroleum products in India. Petrol prices, for example, are at a historic high, nearly touching INR100 per litre in some cities in India,” the report said.

“These trends are likely to impart upside risks to headline inflation which has reached 5 per cent in February 2021. Core CPI inflation has also increased to 6.1 per cent in February 2021.”

Besides, the report quoted RBI which indicated that outlook for core inflation may be adversely impacted by broad-based escalation in cost-push pressures in services and manufacturing prices due to increase in industrial raw material prices.

On the upcoming review of the Monetary Policy Framework (MPF), the report said it should be “decided after taking into account the interdependence between fiscal and monetary policies

After completing the period of five years since its inception in February 2015, the MPF is due for a review.

As per the current framework, the RBI was mandated to target a CPI inflation rate at 4 per cent with a tolerance range of ‘+/-2 per cent’, implying an overall CPI inflation range of 2 to 6 per cent.

“This target is to be reviewed once in every five years. In this context, the RBI, in its Report on Currency and Finance 2020-21, released on 26 February 2021, has argued in favour of retaining the current flexible inflation targeting regime and the existing CPI inflation target range.”

The RBI has justified its stand on retaining the 2-6 per cent CPI inflation range based on the argument that a 2 per cent lower limit is consistent with RBI’s estimates of supply shocks and also in line with inflation targets in advanced economies.

Furthermore, RBI cited that the 6 per cent upper limit is consistent with international experience where countries with a large share of food in the CPI basket tend to have higher inflation targets and wider tolerance bands and inflation above 6 per cent can be harmful to growth based on RBI’s threshold estimates.

“The argument pertaining to the lower limit of 2 per cent relevant for advanced economies may need to be examined carefully in India’s context.”

“Experience has also shown that implicit price deflator-based inflation has tended to remain tangibly below the CPI inflation. This has led to a relatively low nominal GDP growth and therefore relatively low tax revenue growth.”