Graphic: Santosh Sharma
Graphic: Santosh Sharma

The need for a hawkish monetary policy committee

What would it take to keep retail inflation from running roughshod above 6%?

Mumbai: What would it take to keep retail inflation from running roughshod above 6%? Two things—a benign print on both non-core and core inflation. On the surface, it would look like we are already there. Core inflation, which excludes food and fuel prices, has decelerated to 4.8% for the first quarter of fiscal year 2017 from about 7% two years ago and nearly double digits in FY13. But more about this later.

Let us start with non-core inflation that includes food and fuel prices. Food inflation has a 45% weight in the Consumer Price Index (CPI) and tends to cause considerable grief to policymakers. Here lies the rub. In the past four-and-a-half years, food inflation has slipped below 4% only four times—July and August 2015, November 2014, and January 2012. The rest of the time, it has been much higher.

Prices rose the fastest in the years with normal rainfall, lest we believe that the continuous drought for two years was the culprit. Be it led by protein-rich items or flare-ups in vegetable prices, food inflation nine out of 10 times remained well above 6%. In short, getting food inflation below 6% is going to be tough.

For an overall retail inflation print of below 6%, the burden now falls on the rest of the items—fuel and core inflationto behave. The gains from lower fuel prices are mostly behind us. The decline in retail inflation in the past four-and-a-half years has been predominantly led by decelerating core inflation. But core inflation tends to be sticky. It refused to budge below 9% for most of FY13 and then stubbornly clung to 6% in FY14. For the first three months of FY17, it has been around 5%. The credit goes to both a cautious monetary policy by the Reserve Bank of India (RBI) and fiscal frugality by the government.

But the government has already set in motion an inflationary spurt by giving wage hikes to its employees. Armed with higher wages, government employees are bound to raise consumption. A monetary policy report of RBI in April points to the stickiness of services inflation, especially of discretionary items. And let’s not forget that one reason why inflation is so low is because of low commodity prices and low growth in the manufacturing sector. What happens when that changes?

So what are we left with to keep inflation below 6%? It certainly would not be a dovish monetary policy committee as the markets would have you believe. A hawkish monetary policy committee, anyone?

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