Inflation

1. Should the Monetary Policy Committee
Adopt a Hawkish Stance?

2. 2
I n d i a I n f l a t i o n S c e n a r i o
• The Government of India has set the inflation target of
4% (with a tolerance of +/-2% for the period between
August 5, 2016 to March 31, 2021.
• Although inflation is measured by Wholesale Price Index
(WPI) as well as Consumer Price Index (CPI), the
Reserve Bank of India is using CPI Combined (Rural and
Urban) as the chief measure of inflation for the purpose
of framing monitory policies.
Inflation Target
4%
(+/- 2%)
Time Duration
August 5, 2016 -
March 31, 2021
4.58%
4.96%
5.24%
8.50%
5.11%
7.91%
2.80%
3%
0.00% 4.00% 8.00%
General Index (All Groups)
Miscellaneous
Fuel & Light
Housing
Clothing & Footwear
Pan, Tobacco & Intoxicants
Consumer Food Price Index
Food & Beverages
Figure 1: India Inflation Rates, By Group, April 2018 (%)
Source: MOSPI
• In April 2018, the core inflation (inflation that does
not take into account food and fuel) skyrocketed to
a 44 month high of 5.9%. [1]
[1] BloombergQuint
Threats to Meting the Inflation Target
• Rising Crude Oil Prices
• Depreciation of Rupee against US Dollar
• Foreign Outflows
• Hurting Foreign Reserves
• Increased Minimum Support Price for
Monsoon-Sown Crops by the Government
of India

3. R e l a t i o n B e t w e e n O i l P r i c e s & I n f l a t i o n
3
48.48 51.7
56.15 57.51
62.71 64.37
69.08
65.32 66.02
72.11
76.98 74.41
2.36
3.36 3.28
3.58
4.88
5.21 5.07
4.44 4.28
4.58
4.87 5.00
0
2
4
6
8
0
20
40
60
80
100
Jul-17 Aug-17 Sep-17 Oct-17 Nov-17 Dec-17 Jan-18 Feb-18 Mar-18 Apr-18 May-18 Jun-18
Brent Crude Oil (USD per Barrel) India Inflation Rate
Source: MOSPI, Statista
Brent Crude Oil Price (USD per Barrel) and Inflation Rate in India (%), July 2017-June 2018
• In manufacturing sector, increase in crude oil prices results in augmented raw material costs, which in turn push the
cost of production of a product. As a result, the excessive costs are passed on to the consumer. Therefore, surge in
oil prices contribute to increase in inflation rate.
• India meets roughly 80% of the demand for crude oil through imports. Saudi Arabia, Iraq and Iran are the largest
source of crude oil import to the country.
• Since India imports large quantities of crude oil, the volatility of oil prices have a major impact on the inflation rate
of the country.

4. R e l a t i o n B e t w e e n O i l P r i c e s & I n f l a t i o n
• In April 2018, the inflation rate of India recorded a
three month high owing to the uptick in crude oil
prices.
• Sanctions imposed by the US on Venezuela and Iran in
May 2018 could result in lower oil production, thereby
increasing the cost even further.
• Analysts estimate that for every increase of USD 10 in
the price of crude oil, current account deficit (CAD) and
fiscal deficit of India could worsen by 0.4% and 0.1% of
the GDP respectively. [1]
• Rising oil prices coupled with depreciating value of
rupee against the US Dollar could create headwinds for
the economic growth of the country.
4
Key Concerns
• United States Energy Information Administration
(EIA) projected crude oil prices to drop from USD
70.68 per barrel in 2017 to USD 65.98 per barrel in
2019 on account of higher output from Saudi Arabia
and the US.
• Ministry of External Affairs declared that sanctions
imposed by the US would not hamper the bilateral
trade of India with Iran and Venezuela.
Positive Outlook
[1] Nomura

5. T h r e a t o f D e p r e c i a t i n g R u p e e & F o r e i g n O u t f l o w s
5
60
61
62
63
64
65
66
67
68
69
01/01/2018 26/01/2018 20/02/2018 17/03/2018 11/04/2018 06/05/2018 31/05/2018
Figure 3: US Dollar to Indian Rupee Conversion Rate, January 2018-May 2018
Source: Reserve Bank of India
22,272
-11,674
2,662
-15,561
-29,776
-45,000
-30,000
-15,000
0
15,000
30,000
January February March April May
Source: National Securities Depository Limited
Figure 4: Foreign Portfolio Investment to India,
January 2018-May 2018 (INR Crores)
• On 24th May 2018, the Rupee plummeted to
INR 68.38 against USD 1. Furthermore, foreign
portfolio investors have sold a net value of
more than 32,000 Crores in the first 5 months
of 2018 and have sold a net value more than
54,349 Crores since February.
• The last time India faced a scenario of large
scale foreign outflows was during the period of
demonetization of high currency notes in
November 2016.
• Depreciating value of Indian Rupee against the US Dollar negatively impacts the Purchasing Power Parity of the
country, which results in increased consumer prices. Furthermore, foreign outflows from India exacerbates the
situation by hurting the value of Indian Rupee in the global market.

6. F o r e i g n R e s e r v e s S c e n a r i o & I m p a c t o f I m p r o v e d M S P
6
• In order to negate the effects of depreciating value of Indian Rupee against the US Dollar and currency
outflows, the Reserve Bank of India intervened to stabilise the economy. RBI is selling US Dollars in the global
market to control the slide of the Indian Rupee.
426.1
423.6
420.4 418.9 417.7
415.1
13th April 20th April 27th April 4th May 11th May 18th May
Figure 5: India Total Foreign Reserves, April 2018-May 2018 (USD Billion)
Source: Reserve Bank of India
• During the 5 weeks between 13th April and 18th May, foreign reserves of India shrunk by around USD 11 Billion.
• Minimum Support Price (MSP) of at least 50% more than the cost of agricultural produce of monsoon-sown
crops offered by the Government of India in the 2018 Budget poses another threat to rising inflation in the
country.
• The policy was introduced to ease the dwindling state of farmers in the country. However, this move is expected
to fan food prices, thereby leading to food inflation. The exact magnitude of the repercussions of MSP could only
be gauged by October (the time of harvest for monsoon-sown crops)
• However, a good monsoon could ease food prices and negate the negative impact of higher MSPs on inflation.

7. P o s s i b l e S o l u t i o n s f o r M a n a g i n g I n f l a t i o n R a t e
7
Increasing Interest Rate
• Increasing interest rates result in fewer loans being secured, which in turn results in
subdued consumer spending. Consequently, prices will drop and inflation would be under
control.
• Michael Patra, member of MCP, suggested an increment of 25 basis points on interest
rates in the meeting held in April, 2018.
Hiking the Reserve Mandates
• Through increasing the reserve cash requirements that the commercial banks have to
hold, the amount of money that could be lent would reduce. As a result, the loans would
be fewer and consumer spending would reduce.
Limiting the Supply of Money
• Calling in loans that are owed to the Government of India by Public Sector Units, Banks
and other organization can improve the purse of the government as well as control
consumer spending by lowering money.
1
2
3

8. C o n c l u s i o n
8
High Oil Prices
Depreciation of INR
Foreign Outflows
Low Foreign Reserves
Higher MSP
Impact Analysis of Different Parameters on Inflation
Low Impact Medium Impact High Impact
• At present, the inflation rate is only little higher than the target rate. However, if the cost of crude oil remains high
for a longer period, there could be a cascading effect resulting in high consumer prices, trade deficit and further
devaluation of the currency.
• As a precautionary measure, the Monitory Policy Committee should adopt a hawkish stance to combat inflation in
India and not allow inflation to offset the economic growth of the country.
• Increasing the rate of interest marginally could keep the inflation rates in check.