Retail inflation surged to a 14-month high of 6.2% in October, defying the Reserve Bank of India’s (RBI) efforts to keep it under control. The spike, driven mainly by rising food prices, breached the upper limit of the central bank’s comfort range. This high inflation rate is not only dampening hopes for a rate cut by the Monetary Policy Committee (MPC) in December but also straining middle-class budgets and posing risks to India’s economic momentum.
Consumer Price Index (CPI)-based food inflation reached 10.87% in October, marking a 15-month peak. The surge was fuelled by sharp price increases in vegetables (up 42.18%), fruits (8.43%), oils and fats (9.51%), and cereals (6.94%), according to data from the National Statistical Office (NSO). Core inflation, which excludes volatile food and fuel prices, also rose to a 10-month high of 3.67%, spurred by telecom tariff hikes and increased gold prices.
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No rate cuts in sight
Given that CPI inflation is projected to exceed the MPC’s estimate of 4.8% for the December quarter of FY25 by 60-70 basis points, the chances of a rate cut in the upcoming policy review seem “ruled out,” according to ICRA economist Aditi Nayar. A modest rate cut cycle of 50 basis points might begin in February 2025 or later, but with inflation unlikely to return to the 4% medium-term target until at least 2026, the rate cut could face further delays.
In October, the MPC held the policy interest rate at 6.5% for the tenth consecutive time, changing its stance from “withdrawal of accommodation” to neutral. However, RBI Governor Shaktikanta Das recently indicated that October’s inflation print would likely surpass September’s, dampening hopes of a policy shift.
Middle class budgets under pressure
The current inflation spike has hit essential food items like vegetables and edible oils, which are staples for households across India. This surge in food prices can be traced to both domestic and international factors. Erratic rainfall patterns have impacted the production of key vegetables like tomatoes, while the government’s decision to raise import duties on edible oils has added to household expenses.
Middle class families are especially feeling the impact, as shown by a sharp slowdown in household spending. Citibank’s index on urban consumption hit a two-year low, tracking declines in airline bookings, fuel sales, and wages. The outlook remains challenging, with Citibank’s chief India economist Samiran Chakraborty noting that key macro drivers are unfavourable. Consumer spending has also fallen, with the Nifty FMCG index dropping by 13% since early October, reflecting the impact of inflation on consumer stocks.
The recent surge in inflation has adversely affected India’s financial markets. On November 13, 2024, Indian stocks declined, with the NSE Nifty 50 dropping by 0.7% to 23,714.55 and the BSE Sensex falling by 0.53% to 78,264.19. This downturn is attributed to rising domestic retail inflation, which has diminished expectations for an interest rate cut in the near future. Foreign investors have withdrawn approximately $14 billion from Indian stocks since their peak on September 27, leading to a nearly 10% decline in benchmark indices. This trend reflects growing concerns about the sustainability of India’s economic growth amidst persistent inflationary pressures.
Persistent inflation is altering consumer behaviour, particularly among the middle class. High food prices have led to reduced spending on discretionary items, affecting sectors such as fast-moving consumer goods (FMCG) and dining. Major consumer goods companies have reported declines in sales volumes, and fast-food chains are experiencing reduced same-store sales as consumers opt for more budget-friendly options. This shift in spending patterns underscores the broader economic impact of sustained inflation on consumer confidence and demand.
Geopolitical and policy risks intensify
While the RBI’s tolerance threshold for inflation is 6%, rising import taxes, climate-related risks, and potential trade policy shifts under the Trump-led administration in the U.S. could worsen the inflationary outlook. Although India’s economy is projected to grow at a healthy 7.2% this fiscal year, persistent inflation could erode purchasing power and dampen consumer confidence, posing risks to sustained growth.
The escalating inflation has significant political ramifications, particularly as political parties vie for support from women voters amid economic challenges. In response to rising inflation and unemployment, parties are offering cash handouts to women, adding substantial fiscal burdens. Over a third of Indian states are spending around 2 trillion rupees annually on these programs. While these initiatives aim to provide financial relief, they also contribute to higher budget deficits and may necessitate reallocations from capital expenditures, potentially impacting long-term economic stability.
The RBI has limited options to combat inflation and may feel compelled to keep interest rates high to curb price rises. However, persistently high interest rates could hinder economic growth. Intensifying geopolitical tensions also threaten energy supplies and may push crude oil prices higher, adding to inflationary pressures. Policymakers must balance the need to control food prices without stifling economic momentum, as some indicators already point to a slowdown.
Despite the challenges, there is hope that food price pressures may ease with the arrival of the fresh harvest. The outlook for the rabi crop is promising, and ample buffer stocks of cereals, along with a good kharif harvest, could help stabilise food prices. The coming months will be crucial in gauging the ability of the government and RBI to manage inflation and prevent it from spiralling out of control.