The future of inflation

November 13, 2014

(Any opinions expressed here are those of the author and not necessarily those of Thomson Reuters)

Inflation has been easing both at the wholesale and retail level for some time. The RBI would have been pleasantly surprised that CPI came down to 5.5 percent in October, a year before anticipated. Even so, the trend does not appear to be firm enough. There are conflicting factors which pull in different directions, making it difficult to predict how inflation will behave for the rest of the year.

So far, food prices have ruled the CPI, and to some extent, even the WPI. In the food basket, vegetables, fruits, milk, meat and eggs were continuously in short supply and exposed to sharp price escalation. There is still no indication that production has increased to make up for the supply deficit. One possible reason is that the Agricultural Produce Marketing Act prevents farmers from getting market rates, and their response to the price rise has consequently been poor. It is expected that the government will change the act so that farmers can benefit from the market.

International developments have also eased India’s inflation. Crude oil and food prices have declined, some quite significantly. Oil, oil products and some food products like edible oils, pulses, etc. are important components of imports and have high weightage on the inflation index. The fall in international commodity prices will have a dampening effect on inflation. The fall in oil prices will also have a secondary effect by reducing transport costs. Hence the downward pull on inflation can last for a while, provided the exchange rate remains stable.

Surely, the international currency matrix is undergoing a change because of uneven growth in major countries. The U.S. economy has consolidated and the dollar is hardening against most currencies. The danger is that the EU could slip back into recession, more so Germany. The Bank of Japan has resorted to a kind of quantitative easing which has forced the yen to fall. Most emerging market economies including India will find their currencies depreciate, making imports costlier. But the rupee’s fall may be minimal.

Inflation in India may be pulled in different directions by emerging national and international forces. The RBI is extremely sensitive to inflation and has followed a tight money policy. The repo rate was doubled from 4 percent to 8 percent over a period of time but with no impact on inflation. It is now time for the central bank to be more sensitive to growth.

Looking at the emerging trends, it appears that inflation will slow down further both at the wholesale and retail level, and the year may end with CPI at around 5 percent in spite of the deficient monsoon.

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