At least 59% of the increase in inflation is because of the geopolitical conflict, says SBI Research in its latest report, adding that it's futile to blame central banks for high inflation across the world. It also said that the Reserve Bank of India (RBI) will certainly raise rates in the forthcoming June and August policy announcements, and will take it to the pre-pandemic level of 5.15% by August in the wake of a continued increase in inflation.

However, the report raises the question if inflation will tread down "meaningfully" because of such rate hikes if war-related disruptions do not subside quickly.

Retail inflation, measured through the consumer price index (CPI), soared to a multi-year high of 7.79% in April as food and fuel prices saw further hikes during the month. This is the highest rate of inflation recorded in the Indian economy since May 2014. The rate of inflation in March stood at 6.95%.

As per the SBI Research report, the latest inflation numbers reveal that in the rural areas, the impact has been disproportionately higher for food prices. In urban areas, fuel price impact and pass-through have been concerns since the war began.

The RBI, in an off-cycle meet of the monetary policy committee (MPC), hiked the benchmark repo rate by 40 bps to 4.40%. In its last meeting held from April 6-8, the MPC had kept the policy rates unchanged even as inflation reached an eight-month high. The global concerns around high inflation prompted the RBI to take immediate action.

The SBI wing says its study shows that because of war alone, food and beverages — assuming that vegetable price increase was mostly because of seasonal factors that are largely domestic — fuel and light and transport contributed 52% increase in overall inflation since February.

Add to this the input costs on the FMCG sector, and also the contribution of personal care and effects, and the total impact comes to around 59%, purely because of war, it adds.

With the increase in key lending rates, interest on loans is also set to rise as retail loans are benchmarked to an external rate, mostly to the RBI’s repo rate, with a quarterly reset clause. "In a situation of incipient demand recovery post-Covid, the question will be whether growth could be a large casualty in case of large and persistent rate increases, even as inflation prints will continue to be of serious concern."

Making a case for the RBI’s actions, the report says hiking the key lending rates will be positive for the financial system as risks will get repriced. "The situation is different than during the global financial crisis wherein the lending started increasing aggressively from March 2009 onwards much before the rate hike cycle began (March 2010 till March 2012)."

Now the rate hike cycle has begun and the bank lending will increase according to the adequate risk pricing and demand, the report adds.

According to the report, there is one point of caution for the RBI, which is that Indian inflation internals is different than those of advanced economies such as the U.S. Building wage pressures mirrored in the multi-decadal high annual wage growth are fuelling broad-based price pressures across all advanced economies, it said. In contrast, in India, nominal rural wages for both agricultural and non-agricultural labourers picked up during H2 FY22, with the easing of lockdown curbs.

However, the wage growth has remained soft in India, and the weighted contribution of wage growth in CPI build-up remains modest. "Thus, even after rate hikes, inflation will take time to moderate in India," the report adds.

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