“Rising interest rates cannot cool down war-related price gains”

The Reserve Bank of India’s rate hikes may not be able to “sensibly” cool prices while sacrificing growth, as almost three-fifths of the rise in Indian retail inflation since February has been linked to the Ukraine-Russia conflict can, economic researchers at SBI wrote in a report on Monday.

“In a situation where post-COVID demand is beginning to recover, the question will be whether growth could be a major casualty in the event of large and sustained rate hikes, although inflation figures will remain a matter of serious concern,” the SBI economists said Group to wrote chief economic adviser Soumya Kanti Ghosh.

Inflation, as measured by the consumer price index (CPI), reached a nearly eight-year high of 7.8% in April, with rural inflation hitting a 96-month high of 8.4%. The RBI hiked interest rates by 40 basis points at an off-cycle meeting this month and began unwinding pandemic-related monetary accommodation.

“With inflation continuing to rise, it is now almost certain that the RBI will hike rates in the upcoming June and August policy, bringing them to pre-pandemic levels of 5.15% by August,” noted Mr Ghosh. “However, the key challenge for the central bank remains whether inflation will fall significantly from such rate hikes unless war-related disruptions abate quickly,” he added.

Inflation remains a specter to worry about and is unlikely to correct any time soon, the report warned, adding that the impact in rural areas is disproportionately greater due to food prices, while the impact on fuel prices and the Passing on higher costs to producers has had a similar impact on urban inflation since the war in Europe began.

According to a dipstick study by SBI researchers assessing the “exclusive impact of war” on India’s inflation trajectory, food and beverage, fuel and light, and transport contributed 52% to the overall rise in inflation since February. “If we also add the impact of input costs particularly on the FMCG sector and thus add the contribution of personal care and items, the total impact across India comes to 59% due to the war alone,” the economists wrote.

While endorsing the RBI’s drive to dampen inflation through rate hikes, the economists noted that larger hikes could potentially have an impact on emerging growth stimulus. The RBI may also need to use a shorter window to address inflation concerns “given realpolitik challenges in the not too distant future,” they wrote.

SBI economists also warned that wage growth, which has remained weak so far, could still lead to inflation, which could then take time to moderate, despite rate hikes.