Are the markets celebrating too soon?
The sharp rise in the Sensex on Friday, thanks to the diesel price hike and the US Fed’s bond buying plans which promise a flood of liquidity in the months ahead, is clearly not factoring in the short- to medium-term inflationary concerns in the economy.
The bad news on the inflation front is something the market cannot dismiss so easily.
Here’s why the wholesale price index (WPI) number for August is actually worse than its looks
First, it has shot up by a huge margin, from 6.87 percent in July to 7.55 percent.
Second, this rise is over and above the high base of 9.78 percent inflation in August last year. It means, even with a beneficial base effect, inflation is rising faster.
Third, the chances are that even the 7.55 percent will be an underestimate. The provisional June WPI has been revised upwards from 7.25 percent to 7.58 percent. August’s final figures could thus be closer to 8 percent.
Four, the problem is that core inflation – driven by manufacturing, with a weight of 65 percent in the WPI - is up by 0.8 percent from July to 6.14 percent. Core inflation is what the Reserve Bank was trying to douse. Now it has little reason to cut rates in a hurry. This suggests that manufacturers still have pricing power – something costly money was supposed to weaken.
Five, the diesel hike and the LPG dual pricing policy will kick in next month. The September index is thus likely to breach 8 percent, since the primary effect of the diesel hike will be at least 0.6 percent. As the price hike spreads through the economy, the spread effect will be more than 1 percent.
Six, the real impact of food and energy prices will be felt only in the coming months. In August, the index for food articles fell by 0.4 percent. In the coming months, as the impact of the drought and the hike in minimum support prices feeds through to food prices, this part of the index could start acting up.
Seven, overall food inflation is headed for double-digits, as it now hovers around 9.14 percent. Barring veggies, milk, onion and fruit, everything else is in double-digits, with pulses and potato rising by 34 percent and 69 percent in August.
Seven, given the weak performance in exports, the pressure on the rupee will push domestic prices higher in the coming months – unless foreign exchange flows increase. As we enter the busy and festival season of October-November, imports could also rise – pressuring the rupee down and inflation up.
Eight, the UPA’s various scams will result in a cost-push in several areas as spectrum and coal blocks get auctioned, and tariffs start rising as a result. This process could begin from January, when the spectrum auctions conclude, and the coal block auctions could happen after that.
Nine, the consumer price index (CPI), already just under double-digits (9.86 percent in July), is sure to cross to double-digits in August, if the behaviour of the WPI in August is any guide. The urban CPI index did not fall below double-digits even in July.
The bottomline: double-digit inflation is here for now.