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Business News/ Politics / Policy/  Reading the tea leaves on inflation
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Reading the tea leaves on inflation

A look at five bits of data shows that inflationary pressures have not yet adequately abated in India

High inflation continues to be a persistent threat to economic stability. Photo: BloombergPremium
High inflation continues to be a persistent threat to economic stability. Photo: Bloomberg

High inflation continues to be a persistent threat to economic stability. It is one reason why global debt rating companies are not keen to upgrade India’s creditworthiness. The Reserve Bank of India (RBI) has clearly put the fight against inflation at the top of its policy agenda. And for good reason: Inflation has drifted above the comfort level of the Indian central bank for most of the past six years.

There have been some indications in recent weeks that inflation is slowing. It is clearly too early to announce a victory in the long battle against rising prices. There have been several false dawns in recent years, when inflation pressures seemed to abate for a few months before rising again. Mint has attempted to read the tea leaves using five pieces of data to gauge whether inflation has indeed begun to slow. It’s still a mixed prognosis.

1) Global oil prices: India has been held hostage by the global energy markets because of our dependence on imported crude oil. The slide in global oil prices since the end of June has provided welcome relief for India. Lower oil prices directly help the fight against inflation through cheaper domestic energy, but there is also an indirect impact because of a narrower fiscal deficit.

2) Food inflation: Economists have struggled to explain why India has been hit with such high levels of food inflation in recent years. It has been a major driver of consumer price inflation for sure. There are two reasons of hope: global food prices have come down while the government has been cautious about raising domestic farm support prices after nearly a decade of massive increases. But vegetable prices seem to be immune from these developments.

3) Rural wages: The first decade of this century saw massive rural wage increases that were inflationary because they were not linked to productivity gains. The increase in farm support prices combined with higher rural wages were the main indicators of a large shift in the terms of trade in favour of the villages engineered by the two Manmohan Singh governments. Rural wage growth has come off its 2013 highs, but it is still far higher than nominal economic growth.

4) Pricing power: The sharp deceleration of economic growth since 2012 has opened up a large negative output gap, which is the difference between the actual and potential growth rate of any economy, which we have assumed to be 6.5%. The economic underperformance has meant that companies are not in a position to increase prices when demand for their products is weak. The mild recovery in the first quarter of the current fiscal year has brought economic growth close to its potential. It is to be seen whether corporate pricing power improves in case economic growth accelerates without adequate capacity additions on the supply side.

5) Imported inflation: Global inflation continues to be benign. Europe and Japan are close to deflation. So the threat that India will suffer an imported inflationary shock is minimal unless the rupee tumbles in the coming months. Predicting the course of the rupee is a task best left to brave hearts, but the possibility of higher US interest rates around the middle of 2015 has already led to fears that emerging market currencies could face another round of pressure, though India has done well since September 2013 to build its defences against a new round of currency panic in the emerging markets.

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Published: 22 Sep 2014, 12:35 AM IST
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