India's inflation pressures stay
high By Kunal Kumar Kundu
India's latest inflation figures, as shown
in October Wholesale Price Index (WPI) data
released on Wednesday, came in at 7.45%
year-on-year (y-o-y), lower than the 7.81%
increase recorded during September.
What
is disconcerting is that the August inflation
number was again revised upward, this time by 0.46
percentage points to 8.01%, the highest since
September 2011. Between January 2010 and August
this year - 32 months - the inflation number was
unchanged only once; thrice it was revised lower
while it was
revised upward 28 times.
Note: Revisions up to August 2012.
Source: Office of Economic Advisor
This continuous upward revision brings to
question the credibility of the inflation data
and, given its clear upward bias, makes it that
much more difficult for the Reserve Bank of India
to make an appropriate monetary policy call. There
is every likelihood that the September and October
data will be revised upward, perhaps again beyond
8%.
Still, inflation may be close to
peaking out as suggested in the movement of both
the three- and six-month moving average (MMA)
data.
Source: Office of Economic
Advisor, author's calculations
October
inflation data, though it came in according to
this author's expectations, was lower than the
market forecast, possibly due to analysts'
under-estimation of the base effect of food
inflation, which recorded a year-on-year 6.6%.
Food inflation in the same month last year crossed
double digits at 10.2%.
Going forward,
food inflation is likely to inch up (again due to
the base effect), especially during December and
January, though there's no immediate trigger for
runaway food-price gains.
The biggest
contributor to the upward revision of the August
data was caused by adjustment of crude oil prices,
which were initially grossly under-estimated. The
Indian basket of crude oil peaked that month and,
at the same time, the rupee also remained weak.
When the full effect of these factors was
considered, the index for crude petroleum was
revised up more than 10% to 330.1 from 291.7. With
the oil prices softening of late and the rupee
showing some signs of strengthening, inflationary
pressure on that front will ease.
What is
also important to note is that, weak demand (both
international and domestic) will likely help
inflation to remain steady. A weak external
environment is clearly taking its toll and India's
exports (is US dollar terms) shrank during seven
out of the last eight months.
Also, with
domestic demand showing signs of weakness with
high inflation and a high interest rate impacting
consumer spending, it was not a surprise to see
India's industrial production (IP) faltering,
shrinking 0.37% in September.
What is
worse is that the August growth rate was also
revised downward, by 0.47%. This data comes in as
a big jolt since India's festival period has been
in full swing now and this generally tends to
spike up production aided by some build up in
inventory.
Even more worrying is that the
index value itself has been falling since March
(with the exception of May), indicating that worse
may be in store for the economy. Thus, for the
first six months (April-September) of the present
financial year, India's industrial production
virtually remained stagnant (having growth by a
mere 0.1%) compared with the same period in the
previous year, when it grew 5.1%.
An
analysis done by rediff.com shows that during
quarter ending September 2012, while the Indian
corporate sector recorded its highest net profit
growth (with profit margins on the up), the core
revenue grew a mere 9.2% on an annual basis, the
lowest in three years.
If one adjusts for
inflation, it would be safe to conclude that
there's hardly any volume growth, indicating both
poor demand and that the anaemic September
industrial production data is a result of
manufacturers being weary of faltering demand and
hence preferring not to build up inventory,
despite the approaching festival period.
The better margins for September are,
therefore, a result of lower input costs. But now
that the input costs are rising again, margins
will shrink as companies prefer not to pass on
higher costs to end users, thereby moderating the
upward pressure on prices.
Source: Office of Economic
Advisor, author's calculations
Hence the belief that the
headline inflation may be close to peaking. Having said that,
inflation is not expected to ease soon enough to
make the Reserve Bank of India walk down the
monetary easing path now, as the overall inflation
is still way above the bank's comfort zone and the
government is yet to showcase its determination to
ensure fiscal consolidation.
The only way
the central bank can cut interest rates even in
an-above comfort-zone inflation environment would
be when inflation expectations are tamed. The
problem is that with India's investment to gross
domestic product (GDP) ratio falling over the past
few years, the potential GDP growth rate has
shrunk to less than 7%.
Thus, any
improvement in demand will lead to shrinkage in
the output gap, thereby resulting in a spike in
inflation. Under this scenario, the RBI is
unlikely to make its first rate cut move before
the last quarter of the current financial year,
that is in January to March 2013, though any form
of aggressive rate cut is ruled out.
Kunal Kumar Kundu is Senior
Economist and GM, India, Roubini Global Economics.
The views expressed here are those of the
author.
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