RBI Bulletin: Headline Inflation To Average Well Above 6% In Q2, Stagflation Risk Low In India

The Reserve Bank of India (RBI) expects the headline inflation to average well above its upper tolerance limit of 6% for the second quarter of FY24. However, the central bank also believes that the stagflation risk is low in India owing to the easing of financial conditions, stability of the Indian rupee and steady domestic fuel prices. On the global front, RBI said that the recovery is slowing after a robust first quarter.

RBI in its August 2023 bulletin, under the 'State of Economy' section, said, "The uptick in inflation in its June reading mutated in July, with the unprecedented shock to tomato prices spilling over to prices of other vegetables. While core inflation witnessed a moderation, headline inflation is expected to average well above 6 per cent in the second quarter."

The central bank pointed out that domestic drivers such as private consumption and fixed investment are offsetting the drag from the contraction in exports.

Further, RBI shed some light on the risks of stagflation in the country.

Stagflation is referred to as the combination of persistently high inflation along with high unemployment and immobile demand in a country's economy.

In regard to stagflation, RBI said, "The COVID-19 pandemic followed by the war in Ukraine rekindled concerns about stagflation - a combination of economic stagnation with high inflation (World Bank, 2022). Weaker long-term global growth prospects and persistent inflation have intensified this risk more recently. Evidence from 22 economies, particularly those heavily reliant on non-commodity exports, indicates that higher commodity prices and US dollar appreciation are key factors contributing to the risk of weak economic growth and high inflation, particularly in emerging market economies (EMEs)."

RBI said, "India has historically faced multiple episodes of simultaneous occurrence of high inflation and low growth."

The central bank took into consideration the historical analysis of high stagflation risks of India which were encountered in certain periods such as the Asian Crisis (1997-98), the Global Financial Crisis (2007-09), the taper tantrum (2013), and the COVID-19 pandemic.

It added, "Currently, however, stagflation risk remains low for India with a probability of only 3 per cent with the easing of financial conditions, stability of the INR/USD exchange rate and steady domestic fuel prices."

Coming to the latest monetary policy released earlier in August, where, the central bank voted to keep the repo rate unchanged at 6.50% along with the 'withdrawal of accommodation' stance, meanwhile retaining the economic growth forecast to 6.5% for FY24, however, raising its estimates for inflation due to recent price surges. It said, "The main revisions relate to the projections for the second and third quarters, with the forecast for the fourth quarter unchanged. This implies that the MPC expects these large shocks on account of supply disruptions due to adverse weather conditions to dissipate over the next six months."

"The Committee expressed "a readiness to act appropriately to ensure that their effects on the general level of prices do not persist," the bulletin added.

Overall, RBI said, "With industrial production and trade weakening, the global recovery is slowing after a robust first quarter performance. In this stressed global environment, the Indian economy is gathering momentum in the second quarter of 2023-24."