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Five charts that justify scepticism vis-à-vis India’s current inflation levels

LiveMint logoLiveMint 27-02-2017 Tadit Kundu

India’s Consumer Price Inflation (CPI) had the lowest year-on-year (y-o-y) growth in five years in January 2017. Minutes of the 7-8 February meeting of the Reserve Bank of India (RBI) monetary policy committee (MPC) show little comfort with these numbers. In fact, the RBI has changed the stance of its monetary policy from accommodative to neutral. Here are five reasons why the MPC members might be right in their observations.

The current decline in inflation is almost entirely on the back of food inflation. “Core inflation”, or inflation in the commodity basket, excluding volatile items like food and fuel, has displayed a stickiness of growth rate at around 5% y-o-y and above the headline inflation reading for five straight months, as noted by a recent piece in Mint. Consequently, the MPC expressed concerns over the relatively high core inflation, which is an indicator of underlying price pressure in the economy. The Wholesale Price Index, which has a much lower weight of food items than the CPI, increased in January 2017.

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Even the fall in food prices in India is against the global trend. While there is no one-to-one relation between Indian food prices and global food prices, and the latter depends more on domestic factors like rural wages and minimum support prices (MSP), the global food economy does affect prices in the medium term through its acknowledgement in MSP calculations by the Commission on Agricultural Costs and Prices and important food imports such as edible oils and pulses. The point being, it is risky to assume that Indian food prices can continue to move against the global trend.

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The apparent dichotomy between domestic and global food price movement in India looks less puzzling once we disaggregate various components of CPI’s food basket. 90% of the entire decline in inflation post October 2016, the last month before demonetisation, is attributable to the fall in prices of vegetables and pulses. In fact, 60% of the decline in inflation, post demonetisation, is on account of vegetable prices alone. While the moderation in pulse prices could be on reports of record production this year, the crash in vegetable prices seems to be driven by distress sales amid liquidity crunch post demonetisation. Most vegetables have reported a much sharper fall in prices compared to the situation a year ago. This suggests that there is more to the fall in vegetable prices than just seasonality.

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MPC minutes show that most members recognized the potential impact of demonetisation on vegetable prices while RBI governor Urijit Patel remarked that “past experience suggests that the rebound in vegetable prices could be sharper than normal”. Indeed, it is common for decline in vegetable prices to be followed by a sharp rebound.

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The MPC is not alone in being cautious about inflation going up in the near future. January’s low inflation reading could be the trough and it is likely to be in the range of 5.5-6.0% in the second half of calendar year 2017, according to a report by Nomura Holdings Inc. Consequently, RBI’s inflation projection of 4.5-5.0% in H2 FY18 (year-ending March 2018) might be “too optimistic”, said Nomura India chief economist Sonal Varma in the note. Remonetisation, higher MSPs this year and gradual pick-up in rural wages are likely to drive inflation higher, according to the note. There are differing voices as well. Slower GDP growth and after-effects of demonetisation could lead to “headline inflation remaining benign under 4% for the next two quarters”, according to a report by Upasna Bhardwaj, Suvodeep Rakshit and Madhavi Arora, analysts at Kotak Mahindra Bank Ltd.

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