For two successive months, inflation has come in at less than 1 per cent. What are its implications for the economy? First, the low CPI inflation rates are in part due to the statistical base effect of high numbers last year. Households are not too convinced about low inflation. The RBI surveys on inflation perception reveal that in November, households put inflation at 6.6 per cent and the three months ahead rate was 7.6 per cent. While these numbers are lower than in the previous survey rounds, these figures do show that perceptions are quite different on the ground.
Second, these numbers are a conundrum for the RBI when it comes to interest rates. In December, when the MPC lowered the repo rate, inflation was low and growth very buoyant. In February, when the committee will deliberate again on rates, the situation will be the same. Inflation will remain low — the December number is likely to be less than or around 1 per cent. Logically, rates should be lowered again. But what will happen when inflation rises because of the low base effect? Will rates be increased?
Third, low inflation is a cause for concern because when food inflation is negative, farmers could be getting lower income even though production was very good for the kharif crops. This has ripple effects. If rural incomes are impacted, rural spending power gets constrained, and the benefits of GST 2.0 could likely dissipate. It has been reported that for crops like soybean and pulses, sales were reckoned lower than MSP in October and early November.
Fourth, from the point of view of manufacturing, low inflation, especially on the wholesale side, is not good news as it also means diminishing pricing power. While higher output is a major contributor to profits for companies, prices matter. In the case of CPI as well, the core component witnessed higher inflation mainly due to products like gold. It is low for manufactured products. All this means that there has also been some erosion in pricing power, which can be a challenge if it persists.
Fifth, lower inflation has already caused some slowing down of GST collections. Collections have also been impacted by lower tax rates. The question is, will growth in tax revenues persist with persistently low inflation?
Sixth, low inflation has led to a situation where nominal GDP growth has tended to be only marginally higher than real GDP as against an average difference of 3-4 percentage points in the past. Low nominal growth poses a challenge for meeting the fiscal deficit targets. It would be interesting to see what nominal growth number is used when projecting fiscal numbers for FY27.
Low inflation thus has different implications for different players. Some sections of households may benefit, while some producers may be adversely impacted. The minimum amount of inflation that is needed to keep the economy ticking is around 4 per cent in our case — the target for monetary policy.
