With markets depressed, capital inflows dried out, global fears touching 2008 levels and domestic output on a steady decline, how much would sticky, persistent inflation matter to the Reserve Bank of India (RBI) as it reviews monetary policy on Friday? By a whisker, shall we say, or more?
At this point, RBI is the only central bank looking uphill when appraising inflation risk and interest rates. Other central banks in Indonesia, Korea, Malaysia, and the Philippines are standing still, while some like Brazil are already on their way down. Closer to home, China’s policymakers are highlighting the risks of over-tightening in the light of cumulative lagged effects of past monetary policy actions.
You could argue India is different. China is already seeing some price moderation whereas India - with headline inflation above 9.5% year-on-year for nine consecutive months and eleven interest rate increases – saw a further spike in the inflation rate to 9.78% in August. Accounting for seasonality shows that the overall WPI inflation rate actually remains steady at 9.8% for past two months now
Food prices, manufactured and otherwise, contributed the most to the August headline price increase; although the monthly momentum in core – or non-food manufactured goods - inflation showed a slight resurgence in August, its contribution to overall inflation remains in the 3-4 percentage points range for six months now. This includes the pass-through of higher administered fuel prices as well the input price increases from abroad passed on by domestic producers.
Yet India is not immune to winds blowing from abroad, especially oil and other commodity prices, which play a large role in defining where India’s non-food manufactured goods inflation is going. Prognosis on this appears to be positive ahead from recent projections of the International Energy Agency: this predicts global oil demand falling in 2011 and 2012, which would suggest moderating prices ahead. On the other hand, a QE3 from the US Federal Reserve, which will ponder over these decisions for a couple of days next week, could have speculators pushing up prices.
Domestically, glimmers of success of past monetary actions are visible in declining capital goods production, falling consumer demand and credit growth as well as slowing GDP growth in the first quarter of 2011-12.
Ahead, leading indicators like the PMI (purchasing managers’ index) predict declining manufacturing and export activity, with the new export orders index dropping to 45 from 56 in the last three months. And, as in the Chinese case, the full impact of past actions is yet to fully unfold. A forward-looking scenario then suggests a hawkish tone retaining inflation risk as the uppermost objective with an increased recognition of external risks, tilting the balance towards ‘wait-and-watch’ now. This need not necessarily mean the RBI cannot raise rates at the mid-term October review; by then it will be clearer as to where US monetary policy and oil prices are headed.
But it may not be so easy for RBI to remain passive to a 9.78% headline inflation rate, which will be probably be revised upwards a month later!
Renu Kohli is a macroeconomist and a former staff member of the International Monetary Fund and the Reserve Bank of India.