Why inflation, inching closer to 6 per cent, will make retail loans dearer

The Reserve Bank of India (RBI) may have to raise interest rates further over the next few quarters as inflationary pressures persist, making personal and home loans dearer, and increasing the costs of doing business. High prices of goods and costlier loans could dampen festive season consumption.The latest data from the Ministry of Statistics and Programme Implementation show that retail inflation rose to 5.54 per cent in September, compared to an inflation of 4.84 per cent in August. This is the highest reading since January and the highest under the revised Consumer Price Index (CPI) series. Inflation was more pronounced in rural areas, at 6.08 per cent, than in urban areas, where it stood at 4.88 per cent.Inflation has remained above the RBI’s 4 per cent target for the fourth consecutive month, driven primarily by rising food prices. Food inflation climbed to 7.36 per cent in September, with higher vegetable prices accounting for much of the increase. Sugar, fruits, edible oils, cereals and milk also recorded significant price gains. The upper tolerance limit is 6 per cent under the RBI’s inflation-targeting framework.Crisil attributes the rise to the confluence of three adverse factors: a statistical base effect, surging onion prices and an unusual, near-synchronised increase in global prices of commodities that feed into domestic markets, including rice, wheat, maize, vegetable oils and sugar. These commodities accounted for about a fifth of overall food inflation in September, up from around 15 per cent in April. “October inflation is edging closer to 6 per cent, which is the upper tolerance limit of the RBI’s target,” HSBC said in a research note. While vegetable prices eased somewhat in the first 10 days of October and sugar prices declined following government intervention, including stock limits and duty-free imports, the outlook remains uncertain.“El Nio conditions are expected to intensify further, according to meteorologists, which could stoke food prices,” the note said. It also flagged the possibility of further cost pressures, noting that the gap between non-food wholesale price inflation and CPI inflation suggests that higher input costs have yet to be fully passed on to consumers. Commercial LPG cylinder prices were raised in October, alongside increases in the prices of electronics.If September’s inflation spike marks the beginning of a sustained run of elevated readings, or if underlying price pressures strengthen further, the case for additional monetary tightening could gain momentum. Higher interest rates could also help widen India’s interest rate differential with the US and provide some support to the rupee.Soumya Kanti Ghosh, group chief economic adviser at the State Bank of India, said the inflation outlook remained subject to significant upside risks from deficient monsoon conditions, El Nio effects and elevated energy and other commodity prices. These factors could sustain supply-side pressures.He also pointed to the broadening of inflationary pressures across the consumption basket. The number of commodities accounting for 75 per cent of the CPI’s weighted contribution rose from 25 in August to 31 in September, suggesting that price pressures were spreading beyond a handful of items.“Against this backdrop, alongside persistent rupee weakness, we believe that the peak policy rate could reach 6 per cent, necessitating a calibrated but firm monetary policy response to contain inflation and anchor expectations,” Ghosh said.He says the RBI could consider two options to soften inflation. The first would be a calibrated tightening approach, involving a 25-basis-point increase in the marginal standing facility (MSF) rate, from 5.75 per cent to 6 per cent, followed by a 25-basis-point hike in the repo rate in December. This would ultimately take the MSF rate to 6.25 per cent.The second option would be a more decisive 50-basis-point increase in the repo rate at the December policy review, signalling a stronger commitment to containing inflation. The choice between the two approaches would depend on how persistent inflationary pressures prove to be and how the rupee performs in the coming months, he says.Ultimately, the RBI’s response will hinge on the trajectory of underlying inflation, food and energy prices, and the rupee. Its priority will be to ensure that temporary supply-side shocks do not translate into broader and more persistent price pressures.Subscribe to India Today Magazine- Ends