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This is just the beginning of the rise in core inflation

This is just the beginning of the rise in core inflation
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First Published: Mon, Mar 14 2011. 11 04 PM IST
Updated: Mon, Mar 14 2011. 11 04 PM IST
Relief over lower oil prices prevailed over concerns about the higher-than-expected inflation on Monday, as the Sensex did much better than other markets.
Also See | Getting Pricey(PDF)
That isn’t surprising, because a 25 basis points rate hike was priced in and nobody expects the Reserve Bank of India (RBI) to hike more because of the higher inflation number. That’s why the rate-sensitive sector indices also ended the day in the green.
That said, inflation in primary articles is now being supplanted by higher core inflation, or inflation in “non-food manufactured products”. Unlike fuel prices, which are dependent on global factors, or food price inflation, which may be at least partly the result of insufficient supply, core inflation is dependent on the strength of demand in the economy and is something RBI has control over, which is why it tracks it closely.
Some manufactured product prices show high month-on-month increases. Take cotton textiles, up 4.83%, basic metal alloys and metal products, up 1.68%, rubber and plastic products, up 2.05%, or chemicals and chemical products, higher by 1.69%. Is pricing power back?
To answer that question, consider the recent RBI quarterly industrial outlook survey, which surveys companies in the manufacturing sector about their assessment of the January-March 2011 quarter. A net 18.6% of those surveyed said they would increase selling prices during the quarter—that’s against a net 17% in the previous quarter. The survey also finds that a far larger percentage of respondents expect a rise in raw material prices. In other words, companies are still not passing on the full extent of the rise in input costs.
This will change when companies start bumping up against their full productive capacity. The RBI survey showed that a net 9.5% of respondents expected “above normal” capacity utilization in the current quarter. The survey says, “The overall level of capacity utilization is assessed to be normal with respect to average capacity in the last four quarters…assessment of production capacity with regard to expected demand in (the) next six months also shows that there will be adequate capacity in the current as well as in the next quarter.”
On the other hand, the data suggests that high interest rates are already having an impact on capacity expansion. In other words, this is probably just the beginning of the rise in core inflation.
Graphic by Sandeep Bhatnagar/Mint
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First Published: Mon, Mar 14 2011. 11 04 PM IST