If you think the worst is over on inflation, think again. Despite the let-up in headline numbers to 8.7 percent in April, after four straight months of 9 percent plus growth, the chances are that we are actually sitting on double-digit inflation at present. And the probability is tilted towards high inflation in the near future as well.
Four reasons why.
One, the February Wholesale Price Index (WPI) has got revised upwards by over 2 points (from 146 to 148.1). With the same increase in the April index, we have a cool 10.2 percent inflation and a March inflation figure of 10.6 percent. Of course, it can be argued that the February figure need not repeat itself, but neither can it be ignored.Second, petrol prices have been increased and the threat of a diesel price hike is very real. Petrol prices were increased by Rs 5 a litre earlier in the week, hiking them to between Rs 63.4 and Rs 68.3 across the four major metros in the country.
Recently, Finance Minister Pranab Mukherjee hinted at a diesel, kerosene and cooking gas price hike as well. Diesel prices alone could be increased by Rs 2, according to some reports. Fuel price hikes not only impact inflation directly, they also have a second round effect by way of increasing transportation costs for goods from their point of production to the marketplace.
According to Dr Narendra Jadhav, economist and member of the Planning Commission, a Re 1 increase in "petrol and diesel prices in the domestic market could lead to a direct and immediate impact on WPI inflation to the extent of about 25 basis points (0.25 percent) and a total impact of about 50 basis points over a period of time." Applied to the current context, this means there will be at least a 1 percentage point increase in inflation going forward, if not more.
Third, so far we have witnessed supply side pressures to inflation because of food prices, but with a pick up in growth, "core inflation", as defined by inflation beyond food and fuel prices, is also on the rise.
This is most evident in manufactured product prices, which account for a 65 percent weight in overall WPI. The contribution of manufactured products in overall inflation exceeded that of primary articles for the first time after 19 months in March 2011. This trend means that demand side inflation is on the rise - in addition to a still strong (even if slowing) primary articles figure.
Fourth, while there is no denying the justification for wage hikes under the Mahatma Gandhi National Rural Employment Guarantee Scheme (NREGS) in line with inflation, it has been flagged as inflationary. In its January Macroeconomic and Monetary Developments report, the RBI had said "MGNREGS...has the potential to raise the wage bargaining power even in the unorganised sector, particularly in the agriculture and construction sectors, besides raising rural demand at a faster pace relative to production of cereals and non-cereal food items."
But, there is also a balancing factor. And, a wild card.
The Reserve Bank of India has tightened interest rates aggressively in the recent past, with the repo (the rate at which RBI lends overnight money to banks) and reverse repo rates at 7.25 percent and 6.25 percent, respectively. This, in turn, has led to higher lending rates in the system, which will slow down growth in rate-sensitive sectors like real estate, consumer durables, and autos, among others. Some cooling off in demand side pressures on inflation are likely to abate as a result.
The wild card, of course, is the monsoon, which could swing any way. The Indian Meteorological Department has forecasts a normal monsoon. But the actual results remain to be seen. Moreover, even with an overall normal monsoon, the spatial distribution can be critical. A good monsoon for India can lower food prices, thus positively impacting inflation and vice-versa.
The upshot? A high inflation period is quite likely to remain, with rising interest rates providing some moderation and monsoon remaining either a bane or a boon. We will know soon.
Published Date: May 18, 2011 07:56 AM | Updated Date: Dec 20, 2014 04:58 AM