Adverse climate events can increase inflation

Adverse climate events can increase inflation

Subject : Economy

Section: Inflation and unemployment

Context: RBI Governor noted in the MPC minutes that adverse climate events can change inflation trajectory.

Key Points:

• The MPC panel has revised the CPI projection to 5.1 per cent and the real GDP growth target at 6.5 per cent.
• While inflation has reduced, RBI is committed to bringing it down to target of 4% and thus will stick to “withdrawal of accommodation” stance. (meaning likely to increase rate again in effort to reduce liquidity).
• The RBI has been mandated by the government to keep consumer price index-based inflation (CPI) at 4 per cent with a band of +/- 2 per cent.
• Some of the factors that may keep inflation elevated (putting upside risk on inflation) are:
  • Geo-political tensions: Tensions and conflicts between countries disrupt both supply of key resources and sea/land routes of transport. This has a great impact on prices of key essentials. For example, the Ukraine war led to reduced supply of wheat and edible oil in the international market. Further sanctions on oil producing nations like Russia or Iran often impact the price of crude oil.
  • Uncertainty on crude price trajectory: Fuel prices have a significant impact on inflation both directly through fuel used for transport and indirectly through increased costs of transportation of all the goods in the economy.
  • Volatile financial markets: Disruption in the financial markets also pose further upside risks to price. This is because any turbulence in the financial markets has a direct impact on the FDI and FPI flows which as part of the capital account are essential to balance the current account deficit. Any imbalance can damage the value of Rupee and thus increase inflation. (Note: a weaker rupee is good for exports but bad for importers and vice versa)
  • Adverse climate events: With around 50% of India’s net sown area being rain-fed, any deficiency caused by El-Nino occurrence that seems likely, will through a lower output result in higher food inflation (will impact kharif yields and rabi sowing). This is even more important as already international prices for key food items like rice and sugar are at elevated levels