The second wave of the pandemic has derailed India’s economic recovery, and even before domestic demand recovers fully, another macro-economic threat has reared its head: inflation.

A spike in global commodity prices – on the back of a recovery in global demand and expansion in central bank balance sheets – and pandemic-induced disruptions have raised inflationary risks. This has eroded purchasing power of consumers, acting as a double whammy for those who lost incomes and livelihoods during the lockdowns.

The latest wholesale price inflation (WPI) numbers for the month of April suggest a sharp build-up in factory gate prices. WPI inflation rose to a 11-year high of 10.5% over the year-ago period. This was partly driven by high commodity and fuel prices on a low base. But even sequentially, WPI inflation has gone up. Most worryingly, core WPI inflation (which excludes volatile components such as food and fuel) has continued to rise steadily over the past few months. Rise in prices of metals and manufactured products are driving this surge, and could spill over to retail prices in the coming months.

Headline retail inflation has been relatively benign in recent months but core inflation has been persistently high over the past few months. Even the headline numbers could start rising as commodity prices get passed on to consumers, and pandemic-induced supply disruptions in rural markets drive up prices of food items. Arrivals in mandis (wholesale markets) have already been disrupted in April because of lockdowns, a 26 May report by economists at CRISIL Ltd said.

Commodity Concerns

Global commodity prices have rebounded sharply from the lows seen in early 2020 and have led to a surge in prices across major economies, including India. The current rally in commodities is being led by a surge in prices of industrial and precious metals, especially copper. Demand for copper has grown on the back of investment announcements in the renewable energy sector and rise in global economic activity. Supply disruptions in Peru and Chile have also contributed to the rise.

The rebound in the global manufacturing sector has also pushed up the prices of steel, iron ore, and coal. Production cuts by the oil cartel OPEC have pushed up crude oil prices to much higher levels this year compared to 2020. On a sequential basis, energy prices have gone up by a third in the first quarter of 2021.

Notwithstanding the recent attempts by China to cool commodity prices by ramping up production and cracking down on hoarding of raw materials, commodity prices are likely to be elevated as the economic recovery deepens in China.

Growth Rebound

Apart from China, other major economies such as the US and UK have also seen a sharp bounce-back in economic activity in recent months. Even as India has been forced to impose lockdowns to counter the second wave, other major economies have been able to open up public spaces thanks to faster vaccinations. The rebound in these economies have pushed up global trade and the global demand for raw materials and commodities.

The International Monetary Fund (IMF) expects the global economy to grow at 6% in 2021, against a contraction of 3.3% in 2020. The improved economic outlook is likely to keep up commodity price pressures throughout 2021. Metal prices are expected to rise nearly 30% in 2021 before dropping back in 2022 while oil prices are expected to average $56/bbl this year before inching to $60/bbl in 2022, according to the World Bank’s latest commodities outlook report.

Monetary Easing

The unprecedented expansion in the balance sheets of major central banks has also fuelled inflationary expectations, with bond markets fearing that policymakers may well be behind the curve. Central bankers in the developed markets now seem to be much more comfortable with moderate levels of inflation than they were even a decade ago, when they first began experimenting with unconventional monetary policies.

The US Fed and the European Central Bank have said that monetary policy will remain accommodative till the labour market heals. This means that the historic expansion in central bank balance sheets over the past year is unlikely to be wound down anytime soon.

The absence of inflation since the 2008 global financial crisis may have made central bankers in the West complacent. But in countries with a chronic inflation problem such as India, central bankers do not have such an excuse. If they fail to tame inflationary expectations now, it could become the biggest roadblock to a sustained recovery.

(Puneet Kumar Arora is an assistant professor of economics at Delhi Technological University)

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