Views | Inflation has peaked but is still too high

Views | Inflation has peaked but is still too high

Is it time to announce the end of the inflation scare?

There are good reasons to believe that inflation has peaked. But there is still no case for the Reserve Bank of India to cut interest rates right now, after 13 rate hikes to combat runaway prices. Inflation is still too high for comfort. Data on the inflation expectations of households and signs of a wage-price spiral continue to suggest that high inflation is still embedded in the Indian economy.

The central bank is due to decide its next policy move on Friday, when it is widely expected to announce a pause and perhaps indicate some moves to ease liquidity. The money market -- more specifically the yield curve and the rates of overnight index swaps -- is also signaling expectations that the cost of money will come down in the coming months. Meanwhile, Kaushik Basu expects food inflation to fall to 3% within a month.

But there are still signs that the inflation cauldron is bubbling away. Analysts at investment bank Credit Suisse have pointed out that non-food manufactured inflation -- or core inflation -- has actually increased by 40 basis points over October. Monetary policy makers focus on core inflation rather than on more volatile food and fuel prices, so the new data should be read with caution.

Also, J.P. Morgan economist Jahangir Aziz told a television channel that the sharp decline in food inflation can be explained by the high base of December, January and February of fiscal 2011.

The Indian economy is rapidly losing steam, and could now be expanding at less than its trend rate. Such a gap between actual and potential output is usually disinflationary. The fall in the rupee will feed the price spiral for sure, though the growing fears about a Chinese slowdown will likely help cool commodity prices.

Slowing growth is emerging as the more important worry right now, but it is too soon to say that the inflation problem has been beaten. Negotiating these two challenges at the same time is always a nightmare for policy makers. With no support from New Delhi, it will be up to the men and women in Mumbai to steer the economy through these difficult waters.

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