The global buzzword now is green shoots, or recovery. If that’s the case, we should be wary of the green creepers that accompany it—inflation.
Looking at India’s headline inflation number, the Wholesale Price Index (WPI), it is hard to imagine that there is anything of concern. WPI inflation, last at 0.13%, is hitting 30-year lows these days. But that’s the year-on-year number usually reported: WPI for three months ending May has gone up 2.1%; food itself is up 4.7%. Yes, that’s a reminder of how inaccurately India measures inflation. But that’s the least of our problems for now.
Illustration: Jayachandran / Mint
For a fiscal year where the Reserve Bank of India (RBI) has estimated growth in the broad money supply—what economists call M3—at 17%, the last month shows an annualized growth of at least 20%. Closer home, prices may soon start pinching: A June HSBC report estimates that by the end of the year, oil price inflation will be at 66% and food at 24%. That’s a tax that eats away household incomes and savings, particularly for the poor.
Global crude oil, one of the biggest culprits behind inflationary pressures, recently breached the $70 mark. This, along with food, was the culprit last time too; WPI inflation rose to at least 12% last year in August. But just a year before that it was at fairly benign levels. So what explains this roller coaster?
The financial crisis may have made monetarism—the theory that holds important changes in the money supply—unfashionable in policy circles, but it’s worthwhile to recall Milton Friedman’s adage: Inflation is always and everywhere a monetary phenomenon. The US Federal Reserve kept its policy rate low for much of this decade. Now, it has even started quantitative easing, or directly buying financial assets; in March, it increased the size of its balance sheet by at least $1 trillion. Similarly, the European Central Bank lowered one of its rates to an all-time low in April.
With central banks around the world pumping cash, it is little surprise that it has once again made its way into India. Add to that recent signs that India’s industrial output is improving, and we’re left with both ample cash and increasing demand at hand—the recipe for inflation.
What will Indian monetary authorities do about this? RBI governor D. Subbarao indicated last month that the bank might start thinking about reversing the “expansionary” policies it has been engaged in since October. It’s not our case that the economy is out of the woods; but reviewing this newfound inflation is necessary, lest it mar India’s recovery from the slowdown.
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