Adverse impacts of rising inflation

Synopsis: A rising inflation level adversely impacts the purchasing power of the consumer and discourages lending activities in an economy. India is currently observing an upward trend which may induce RBI to alter its accommodative stance and tilt towards a stricter monetary policy.

Background:

• • RBI has not intervened on high inflation since the onset of the pandemic in order to support growth. It has kept the repo rate unchanged at 4% for more than a year. 
  • But the current spell of inflation is over a high base and a continuation of recent trends will persuade it to turn the focus back on inflation.

Inflation levels:

• • Until April this year, only wholesale inflation (WPI) was on the rise, led by fuel and commodity prices. But in May, even retail inflation (CPI) picked up. 
  • CPI inflation crossed the RBI’s upper limit of 6 percent after five months. A rise in inflation was observed on both, month-on-month and year-on-year basis. 

Impact of Rising Inflation:

• • It hurts lenders and benefits borrowers. For instance, the government stands to benefit as it is the biggest borrower. Rising inflation will lower the national debt load in relation to the size of the economy as it enhances the nominal GDP of a country.
    • The value of past debt and debt servicing costs gets decreased in real terms as inflation rises.
  • It reduces purchasing power and hits private consumption. In the present context, inflation is likely to hit private consumption in rural areas more than in urban areas.
    • This would happen as overall food CPI inflation was lower than non-food inflation since the last past five months. 
    • This indicates that what agriculturalists typically sell is rising at a slower pace than what they do not produce, and have to buy from the market.
    • It is an opposite situation from last year when a normal monsoon, a bumper crop, and high food inflation in wholesale and retail markets added to rural incomes.
  • It puts severe stress on producers of goods, especially a rise in WPI level. While producers seem to be bearing a part of the burden of rising input costs for now, these could get passed on in greater measure to consumers once demand recovers.
  • Rising inflation reduces returns on fixed income instruments, including bank deposits, which account for over 50 percent of households’ financial savings. 
    • This has already induced a shift to riskier asset classes such as equities, which has ramifications for overall financial stability.

Way Ahead:

• • The RBI will have to closely monitor inflation trends and calibrate its policy response.
  • Further given the need for monetary policy to stay accommodative, it might be time to consider other supply-side interventions. For instance, the government can cut excise rates on petroleum products to soften the inflation blow.

Source: Indian Express