This time around, the real inflation challenge comes from the US
There was some good news on inflation front for India and also not some not-so good news. The rate of CPI inflation fell in the month of April and brought it near the 4% mark. But, the news is mixed!
Good news on inflation
The good news on the CPI inflation front was that it fell from 5.52% in Mar-21 to 4.29% in Apr-21. The good news is also that the fall in retail inflation was driven by food inflation which fell from 4.87% to 2.02%. But the most gratifying story is the sticky core inflation falling sharply from 5.96% to 5.20% in April. That is a source of hope that low inflation could be the paradigm of the future. At least, the rate of inflation is now very close to the median level of inflation as outlined by the RBI in its statement of intent.
Some missing blocks too
There are also some counters to the low inflation story in India. Firstly, the lower inflation is largely on account of the base effect of inordinately high inflation in April 2020. Once the base effect is out of the way, we could see core and food inflation picking up. Secondly, the weak rural inflation is apparently driven by weak demand from COVID spreading aggressively in rural areas. That is not good news if low inflation is the result of weak growth. Finally, there is an important aspect of rising inflation in the US. Let us first understand as to why US inflation matters so much to India?
US inflation at 4.2% is the story
It may sound rather intriguing that at a time when India’s CPI inflation is on the way down, the bigger worry is the level of US inflation. The US reported 4.2% CPI inflation for the month of Apr-21 on a yoy basis. This is the highest level of inflation witnessed in the last 12 years and is a full 60 basis points higher than the most pessimistic estimates. Over the last few months, the US Fed has been assuring bond markets about low rates and accommodative stance but the bond yields are not willing to buy that line of argument. Now it is clear why! Inflation in the US is possibly growing too fast.
What 4.2% US inflation means?
It sounds ironic, but from an RBI policy perspective, the US level of inflation may assume more importance than the Indian inflation in the coming months. Here is why! Indian inflation is a known animal and the RBI is clear that it will give precedence to reviving growth over price stability. But India neither has any influence nor any say in US inflation. That is an extraneous factor; yet a very important factor. Higher US inflation will harden US bond yields and make Indian debt paper unattractive. The only option to prevent a sell-off on Indian bonds by FPIs would be a rate hike by the RBI. As we saw in 2018, this can have rather strong repercussions. The moral of the story is that now the US inflation rate will take centerstage for RBI policy!