The RBI’s 3-front war on inflation, explained

Akshara (0:04)

In today's episode, we'll do one deep dive and cover another story for the day. First, we'll talk about the RBI's three-front war on inflation. And then we'll talk about whether tougher pharma rules change who gets prescribed. Welcome back to The Daily Brief by Zeruda, where we cut through the noise to help you understand what's actually happening in the most important stories from business and markets. I'm your host Akshara. Today is Thursday, 15th October.

Coming to the first story.

Now, if you've been following the RBI over the last week or so, you would have noticed it's been unusually busy. It raised interest rates, it rolled out measures to prop up the rupee, and it started pulling money out of the banking system. On the surface, these look like three separate stories. But they're tied together by one thing that affects all of us. Inflation. So each of these moves, directly or indirectly, is part of the RBI's effort to keep prices in check. But to see how they fit together, we first need to understand what's pushing prices up in the first place. So India's retail inflation rose to 5.54% in September, from 4.83% in August. That's how much more a typical basket of goods and services, as tracked by the Consumer Price Index, costs compared to a year ago. And food inflation jumped even more sharply, from 5.97% to 7.74%.

Now part of the story is painfully familiar. Food prices in India live and die by the weather, and the weather hasn't been kind this year. We have covered this before on The Daily Brief, and its effects are now showing up clearly in the numbers. So India received about 13% less rainfall than normal this monsoon, partly because of El Nino, which is a warming of the tropical Pacific that tends to weaken India's monsoon. And a weak monsoon hurts twice. It damages the crops already in the ground, and it leaves less water stored up for the next season. And you can already see this playing out. Rice prices are rising as acreage shrinks, and weak acreage is expected to fall too. And edible oils are a separate headache. India relies heavily on imports for them, so their prices move with global markets. Now, CARE-Edge's September inflation note flags these pressures along with the risk a weak monsoon poses to farm output. And on top of that, energy is getting expensive again, with crude climbing back up to $100 per barrel. But what really caught our eye was how widely price rises are spreading. So CARE-Edge estimates that core inflation, which strips out food and certain energy items, edged up from 4.2% to 4.3%.

Meanwhile, its diffusion index jumped from 72 to 82 So think of this index as a measure of breadth. It tells you how many categories are seeing prices rise faster than before. Now by the same reports count, inflation picked up in 11 of the CPI's 12 major categories. Now it's tempting to look at this and conclude that the economy is overheating, that people are simply buying more than the economy can produce. But we'd be careful with that conclusion. Prices can rise across the board even when demand is perfectly normal. So if fuel gets expensive, almost every business feels it, whether or not its customers are buying more.

Now the RBI made this exact distinction in its press conference, and Governor Sanjay Malhotra said there were very few signs of demand pushing prices up. So in other words, this is supply-led inflation. And the worry instead was that persistent supply shocks might start changing how businesses and people set prices. Now here's how that works. Imagine a transport company whose fuel bill goes up. It raises its freight charges, and now a manufacturer that uses that transporter faces a bigger delivery bill and raises its own prices. Now imagine people start expecting prices to keep rising. Workers ask for bigger raises, businesses build larger price hikes into their plans, and at this point, the original shock is shaping decisions far beyond the business it first hit. That's when inflation becomes really hard to shake off. Which brings us to a tricky question for the RBI. So if inflation is mostly coming from supply problems, what can an interest rate hike actually do? Higher rates don't make it rain after all. Still, on October 7th, the RBI raised the repo rate by 0.25 percentage points to 5.5 percent, its first hike since February 2023 And it also shifted its stance to calibrated tightening. So the repo rate is the rate at which the RBI lends to banks, and it ripples out onto borrowing costs across the economy. So when loans get pricier, households and businesses get more cautious about spending. And with buyers holding back, companies find it harder to keep raising prices. But the bigger point is about expectations. So remember the spiral we just described where people start treating inflation as permanent and bake it into wages and prices? A rate hike signals that the RBI won't let that happen. It can goal expectations today, even if its effect on actual prices takes much longer to show up. But there is another reason the RBI can't sit still, and it has to do with the rest of the world. So in September, both the European Central Bank and the US Federal Reserve raised their rates by 0.25 percentage points.