Macro risks return: Oil markets uneasy, inflation outlook hazy

A week after the Monetary Policy Committee of the Reserve Bank of India (RBI) largely met expectations by keeping interest rates steady in its bi-monthly monetary policy review, the macro-economic situation looks less stable. A combination of factors suggests that it would be over-optimistic to hope that the RBI will cut rates any time soon, and in fact a hardening of its stance might be on the horizon. For one, an examination of the data on consumer price inflation in March 2018 is not entirely reassuring. The headline number may not be disquieting, given that CPI inflation was only 4.3 per cent in March as compared to 4.4 per cent in the previous month. A pattern of easing inflation might seem to be visible in the data: This is the third successive such contraction. However, as many analysts have pointed out, inflation momentum has in fact reversed direction, driven in part by a strengthening housing market. So far in April, food prices have shown a tendency to harden. It might be too much to hope for a continuing easing in consumer prices, therefore. In fact, vegetable prices have usually reversed direction and started increasing by this time in the calendar year.

There are other structural inflation-related concerns that should be taken on board. An apparent recovery in growth seems to be underway after various disruptions that had hit demand — starting with the demonetisation decision in end 2016. This growth recovery would likely shrink the gap between aggregate supply and aggregate demand, causing upward pressure on prices. The other big imponderable is, of course, crude oil prices. Indian inflation is notoriously sensitive to global crude oil prices. But the global oil market has largely been calm and temperate for some time, allowing Indian inflation to take its cues from domestic factors. This might be coming to an end. For one, the agreement between the large oil-producing countries in the Organisation of Petroleum Exporting Countries, or the OPEC cartel, has reportedly significantly reduced the stocks of crude oil held in reserve globally. The re-entry of shale oil capacity in the United States into the market is not causing prices to react as simplistically as was earlier hoped. Crude oil prices were already around $70 a barrel; some global investment advisories now expect that they will go up even further. Several major producers, especially Saudi Arabia, would like to see that. The decision by US President Donald Trump to launch air-strikes against Syria, while limited, caused prices to go up by 2 per cent. If the Syrian civil war expands, and further destabilises the region, then the upward momentum of oil prices might be sufficient to undermine not just Indian inflation management but also the government’s fiscal deficit. That’s bad news for a nation that imports about three-quarters of its oil, but it is not the only reason to explain the reversal in sentiment. Two factors that had weighed on investors before the recent rally — an oversupply of debt from the states and poor demand from banks — continue to linger.

The government’s response will be watched. In an election year, it would be tempted to give in to populism, and protect fuel prices at the pump. But this would hit the fiscal deficit, which would also cause the RBI to err on the side of caution. Minimum support prices for the kharif season are yet to be announced. Macro risks have returned with a bang, and the RBI will no doubt calibrate its response appropriately.