CPI down, IIP up: But it's still too soon to bring out the bubbly

As expected, the Consumer Price Index (CPI) came in lower in May, down from 8.59 percent in April 2014 to 8.28 percent. The Index of Industrial Production (IIP) also surprised on the positive side, registering 3.4 percent growth in April after months of negative or anaemic growth (-0.1 percent in fiscal 2013-14).

Is this cause for celebration? Should the Modi government now expect the Reserve Bank Governor to cut interest rates in his post-Budget policy, or should it temper its expectations?

Methinks there is no cause for bringing out the bubbly yet. A lot of the improvement, both in the CPI and the IIP, has been the result of the base effect - low index numbers in 2013. Interest rates are unlikely to come down anytime soon.

Moreover, there is the looming possibility of a weak monsoon in 2014-15 - with the rainfall expected to be particularly weak in the granary states of the north west due to the El Nino effect.

It is in this context that we should look at the May CPI numbers. For the 8.28 percent overall number was enabled by low inflation in pulses (5.37 percent), oils (zero), and sugar (zero).

If the monsoon fails, it is not cereals (rice and wheat) that may drive inflation, but pulses - which are very sensitive to adverse weather conditions. If pulses inflation shoots up, imports may be needed. Already, there is concern in government about what will happen to onion prices.

Cereal inflation too cannot be ruled out if the government opts for higher minimum support prices due to the weak monsoon.

But the worst news is in the remaining parts of food inflation. In May, milk (11.28 percent), eggs, fish and meat (10.11 percent), veggies (15.27 percent) and fruits (23.17 percent) were all in double digits. The torrid summer is sure to send all these prices up again.

Even more important, fuel inflation was a low 5 percent in May, thanks to the government's decision to hold off diesel prices increases during the elections. This will now bounce back as government hikes diesel prices to eliminate the subsidy altogether, and one has to wait to see what happens on LPG, kerosene and gas prices - all due for revision in the coming weeks, if not months.

A lot depends on what the government chooses to do on energy pricing and minimum support prices for food - the former being biggest area begging for reform.

My prediction is that if the Narendra Modi government opts for big-bang structural reforms, cost-push inflation will worsen in the short term and growth will be weak, but we can expect a sharp rebound from 2015-16 onwards. But if the government opts for incrementalism and compromise, inflation will remain stuck in a high groove and growth will remain anaemic for a much longer period of time. NDA-2 will become a replay of UPA-2. (You can read the full article here).

The problem is inflation in India is structural in nature. I have been saying this for a while, and unless we address the fundamental issues that make inflation endemic, we are not going to see any major moderation in the short or even medium term.

UPA gave food inflation a big push in 2008-09 when it announced dramatic increases in minimum support prices (MSPs) in the range of 30-75 percent (read here). Obviously, this disastrous decision was influenced purely by the need to win the 2009 elections. Food inflation has never looked back since then.

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Updated Date: Jun 12, 2014 18:49:55 IST