Inflation poses a challenge at above 6% in June
The good news was that inflation at 6.26% for Jun-21 was way below the consensus estimate of 6.9%. The bad news was that inflation was just marginally below the May-21 inflation level of 6.3% and well above the RBI tolerance level of 6%. Remember, the 6% is the outer tolerance limit of RBI with respect to inflation and its median inflation target for the Indian economy is 4%. So, the current inflation is still way higher.
Let us turn to the components of inflation. Core inflation (which excludes food and fuel) was slightly down from 6.55% in May to 6.16% in June. However, food inflation spiked from 5.01% to 5.15% in June on the back of higher oil, fat and egg inflation. But the bigger concern for the RBI would be the sharp spike in fuel inflation and transport inflation. Fuel inflation spiked from 11.6% in May-21 to 12.68% in Jun-21 while transport inflation also came in sharply higher at 11.56%. Food inflation was much sharper in rural India.
The steep levels of inflation can be attributed to higher crude prices. Typically, a $10 per barrel increase in crude oil prices lead to a 0.5% rise in inflation in India. Additionally, higher fuel prices and higher transport inflation have strong externalities in the sense that they seep into almost all goods and services. For the RBI, the bigger challenge is the pressure on real rates of interest and the pressure to hike interest rates to compensate investors. We will await the RBI monetary policy in August for greater clarity.
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