The March wholesale price inflation (WPI) data made unpleasant reading, particularly for the Reserve Bank of India (RBI). Inflation jumped up to 9%—a full percentage point above RBI’s most recent forecast made less than a month earlier.
Moreover, the March data likely to have understated the real inflation rate. Initial estimates of WPI continue to experience serial upward revision with January’s provisional estimate of 8.2% pushed up to 9.3%. With upward revisions over the last 12 months averaging 0.7% per month, March’s true inflation rate could be close to 10%.
Upward revisions in turn appear a function of poor response rates. Despite laudable government attempts to revamp and improve the data, only some 40% of the data is still being reported each month, leading to persistent underestimation of inflationary momentum.
What is driving India’s accelerating inflation? Stepped up rates of food inflation, reflecting the structural pressure on protein prices from rising incomes and shifting diets, have clearly been the key source of higher average inflation in recent years. Despite last year’s normal monsoon, food price inflation has not retreated as expected from 2009 surge, proving sticky around 6% to 7%.
With this year’s monsoon expected to be normal, food inflation is likely to run around these levels for the time being, perhaps receding a little later in the year. A worse-than-expected monsoon, however, could yet see food inflation spike back into double-digit territory. Ultimately, supply-side measures, in particular improved infrastructure and irrigation, are key to food inflation falling back below 5% on a sustained basis.
Energy, particularly oil prices, is also inevitably a key driver of inflation. Coal, not oil, prices have actually led the inflationary push from energy prices so far this year but the rise in crude oil prices and the prospect of more, not less, unrest in the Middle East is a clear upside inflation risk for India’s heavily oil-dependent economy. But inflation’s quickening pulse is not primarily a food, or even an energy price, story.
More ominously, it is a broad-based, demand-push core phenomenon as the economy bumps up against its speed limits and inflation expectations drift higher. Our two bespoke measures of underlying inflationary pressure—a US-style, ex-food and energy measure and a more complicated trimmed-mean gauge, which chops out the biggest price swings—suggest broad-based and accelerating manufacturing inflationary pressure. Both show inflation running at annualized rates in excess of 10% over the last six months.
While RBI’s reluctance to tighten monetary policy more rapidly to offset structurally faster rates of food inflation has been understandable, its failure to act more decisively in the face of accelerating demand-pull inflationary pressure is more concerning. Private sector inflation forecasts, including our own, are being marked steadily higher as inflation continues to disappoint.
Rising inflation expectations now threaten an additional ratchet effect to the inflation process. And with scant evidence of the economy losing any momentum with the latest manufacturing surveys robust and credit growth solid, demand push pressures are likely to build further in the short term.
The time for RBI to abandon its so far calibrated approach to policy tightening and push policy more decisively into restrictive territory has therefore now arrived. A 50 basis points rate rise at next week’s annual policy review would signal recognition of the seriousness of the inflationary threat and crucially help stabilize wobbling inflation expectations. One basis point is one-hundredth of a percentage point.
Critics will no doubt argue that such a move takes unnecessary risks with growth, but more today should mean less tomorrow, particularly if the upside risks to inflation from the weather and oil, do indeed crystallize. For central banks, a stitch in time frequently does save nine.
Richard Iley is the chief Asia economist at BNP Paribas .
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