Fuel Tax Cut Likely Eased Inflation In May, But Price Pressures Elevated

Surging retail inflation likely eased in May on lower fuel costs, but price pressures remain elevated, and the rate was expected to have held above the Reserve Bank of India's upper tolerance level of its 2-6 per cent target band for the fifth month in a row.

A Reuters survey of 45 private economists showed inflation measured by the consumer price index (CPI) likely slipped to 7.10 per cent in May from a year ago, down from 7.79 per cent in April. 

Even the range of forecasts for the data, due at 5:30 pm on June 14, showed the lowest expectation of 6.70 per cent was well above the RBI's medium-term target band and the highest forecast of 8.30 per cent, a shocker.

While the government announced a cut in fuel tax to cushion consumers from rising prices and fight high inflation, the complete pass-through was not expected to be felt in consumer prices until this month.

Still, lowering fuel taxes would have briefly helped stem the upward trend in prices and offset soaring food costs.

ANZ economist Dhiraj Nim told Reuters that the government's fuel tax cuts lowered prices by around 10% compared with earlier this year.

"However, food inflation persists to be on a sharply elevated trajectory, especially during the summer months starting from May," said Mr Nim.

That suggests more rate increases are coming from the RBI after it delivered a 40 basis point off-cycle hike in the key repo rate last month and a 50 basis points increase at its meeting last week.

Rate hikes mean higher EMIs on loans, which add to household budgets already stretched from increasing food prices, which have become a major concern for the common folks in the country already reeling from the pandemic.

If the Reuters survey consensus does prove to be accurate, then retail inflation would have remained above the upper tolerance level of the RBI each month this year.

While the central bank faces a dilemma of supporting the nascent recovery from the COVID-19 crisis and at the same time tame surging prices, the RBI now expects inflation to remain above its upper band of 2-6 per cent target this calendar year.

That suggests the central bank has lost control of inflation, which is its primary mandate, as its main target is to keep retail inflation at 4 per cent, with a tolerance level of 2 per cent above or below that rate.

Indeed, if the 4 per cent mandate is strictly taken as the base measure, then inflation has spiralled out of the RBI's reach - the war on the edge of Europe as a reason notwithstanding.

"A lot of the current pressures are very much supply-side driven. There's really little that the RBI can do directly to stem any of this in the short run," Miguel Chanco, chief emerging Asia economist at Pantheon Macroeconomics, told Reuters.