Inflation is getting a free pass in India. Policy makers seem to believe that by not raising interest rates and letting prices bubble up for a bit they will encourage investment and employment and boost post-pandemic growth. In reality, however, the connection between output, jobs and prices may be more complex. Ignoring inflation may just allow it to bite.

India’s politicians well understand that elections can be won or lost over onion prices. With only 83 million people in salaried occupations in a country of 1.4 billion, households don’t have a lot of bargaining power over wages to cope with a higher cost of living. What’s less well appreciated is the differential impact of prices on producers, especially on pandemic-scarred small operations with thin profit margins.

India’s wholesale price index, which tracks goods at factory gates, rose almost 13% from a year earlier in January. The gauge has recorded double-digit increases for 10 straight months, even as the benchmark consumer price index, which also includes services, has only recently breached the top of the central bank’s tolerance range of 2% to 6% annual gains.

Yet, the Reserve Bank of India is being rather sanguine about future inflation and keeping the market guessing about whether interest rates will rise meaningfully this year. In doing so, the RBI is risking its credibility for the sake of a little extra growth. Is this trade-off even worth it if higher prices end up putting small companies out of business?

Think of the 7% difference in the pace of wholesale versus consumer inflation as a cost squeeze. Not all producers can deal with this pressure with equal ease. In the September quarter, when the economy opened up after a deadly second wave of the pandemic, smaller makers of everyday consumer goods captured only 2% of the growth in sales value from a year earlier. Large companies took 76%, with mid-sized firms accounting for the rest, according to NielsenIQ.

Input cost pressures, says the data provider, have forced producers to raise prices, especially for food products and cooking mediums. “This has severely impacted small manufacturers,” NielsenIQ says in its report. Companies with 1 billion rupees ($13 million) or less in sales supply almost a fifth of India’s staples market. In the third quarter of 2021, there were 14% fewer of them than a year earlier.

Some may have folded because of pandemic-related disruption. Others are going out of business because, unlike larger rivals that can absorb a part of the escalation in commodity costs, smaller companies’ already-stretched finances are forcing them to try and pass on the increases to consumers. Not many are succeeding. An industry association has warned that a third of India’s edible oil refining capacity may shutter — and shift to Indonesia or Malaysia — because it’s cheaper to import refined oil.

Prices of edible oil, aluminum, tinplate, plastic, paper and glass are near their highest in a decade, while those of coffee, sugar, wheat and milk are above their 10-year average, Mumbai-based brokerage Prabhudas Lilladher noted last week in its analysis of Nestle India Ltd.’s December quarter earnings. With product and packaging costs spiraling higher, the maker of Maggi, Nescafé and KitKat sacrificed 210 basis points of gross margins to boost revenue by 9% from a year earlier. It squeezed employee costs and overheads to keep operating profitability — the ratio of earnings before interest, taxes, depreciation and amortization to sales — intact.

Smaller firms don’t have this kind of staying power. Many of them have made use of a government credit guarantee to access fresh loans to survive the worst of the pandemic. According to State Bank of India’s economists, the backstop prevented $24 billion in credit to micro, small and medium enterprises from turning bad, protecting the livelihoods of as many as 15 million workers.

However, these businesses aren’t exactly out of the woods. When it came to servicing their debt, credit bureau TransUnion Cibil estimates that 18% of borrowers were in worse shape in March 2021 than when they had taken the emergency loans.

Larger companies are flexing their marketing muscles. Unilever Plc’s India unit recorded its highest market-share gain in a decade during the December quarter. But as financially constrained smaller manufacturers fire workers, the purchasing power of the population threatens to erode further, hurting weak consumer demand, and making it harder for other vulnerable producers to survive.

This is why stagflation risk is high in India. Price spikes in things like clothing and footwear, health, transport and communications seem to be taking a structural turn — and getting entrenched. After two years of the pandemic, “the inflationary trend in these categories instead of subsiding has flared up further even while consumption demand is weak,” says India Ratings and Research Ltd. economist Sunil Kumar Sinha.

The RBI is pushing on a string. Yes, the domestic economy’s recovery from Covid-19 is far from complete. Output in services industries is 24 percentage points lower than before the pandemic, according to Nomura Holdings Inc. But now it’s the job of fiscal policy, which is being kept ultra loose for a third straight year, to deal with deficient demand.

With Dated Brent crude oil at $100 a barrel for the first time since 2014 and the U.S. Federal Reserve embarking on a major tightening campaign, the time for monetary adventurism is over. Allowing domestic prices to get out of hand will not purchase India extra growth. It’ll be just the opposite if inflation ends up bankrupting more of its smaller producers.