India’s sustainable growth requires an inflation level that is manageable, and for long a 4% inflation was considered ideal.
Then why has gross domestic product (GDP) growth fallen for four consecutive quarters when inflation remained below 4% for more than two years?
This is because every economy has to sacrifice a part of its growth, current and potential, to keep prices in check.
Ergo the fact that core inflation has fallen sharply indicates that demand is cooling, which invariably leads to lower growth. After all, producers would first reduce output before prices in response to lower demand.
Core inflation, which excludes food and fuel inflation, was 4.07% in July, sharply down from 5.97% a year ago. That said, core inflation has risen marginally in July from the previous month.
If RBI’s forecasts are anything to go by, retail inflation is likely to remain below 4% for the next one year. This means core inflation could either go down or remain at current levels since food inflation is expected to rise. “We believe this is a temporary phenomenon and the core inflation will ease going forward," said Soumya Kanti Ghosh, chief economist at State Bank of India (SBI).
To be sure, the central bank’s forecast could go wrong as it has many times in the past. But economists expect the big movement in headline retail inflation to be driven by food rather than core inflation.
Food inflation has been rising for the past six consecutive months and an unfavourable base could show a rise in coming months too.
What does soft core inflation mean? It could indicate that consumption demand is likely to remain benign. That in turn would mean growth could be subdued.
Economists fear that the slowdown would only get worse before it gets better and forecasts for the current fiscal year range from the most benign 6.4% of JP Morgan to a more optimistic 7% of RBI.
Indian manufacturers need confidence that demand would pick up from consumers in the coming months. As the festival season kicks off a month down the line, carmakers to soap makers are hoping it would perk up sales.
Perhaps, the recent lending rate cuts by banks could add a push to consumers.