The ‘core’ issue

The striking feature of the inflation data for India in recent months is not the overall trend, as much as the divergence within its main components. In an aggregate sense, inflation — as measured by the annual increase in the official wholesale price index (WPI) — has declined from 8.1 per cent in September to 6.8 per cent in February. The downtrend is sharper when one looks at the price rise in non-food based manufactured goods or ‘core’ inflation, which has fallen from 5.7 to 3.8 per cent during this period. On the other hand, inflation in food articles has gone up from 8.1 to 11.4 per cent. The higher weight to food in the consumer price inflation (CPI), in turn, also explains why inflation based on the latter has risen from 9.7 to 10.9 per cent between September and February.

What can be the policymaker’s response to such a divergent trend — wherein ‘core’ inflation has eased, but inflation for the ‘aam aadmi’ has only worsened over the last six months? If the annual increase in the WPI for non-food manufactured products has dropped to below 4 per cent, from the 8 per cent levels during the October-December quarter of 2011, what it suggests is a significant reduction in pricing power with industry. In normal times, businesses would be able to raise prices for their products, at least to the extent of passing on production cost increases. But in the current environment — where double-digit inflation in fuel, electricity and wage-goods (primarily food) clearly point to cost push pressures — they simply haven’t been able to do so. It means companies today are operating with shrinking margins, and their limited capacity to increase product prices affords enough room for the Reserve Bank of India (RBI) to further ease its policy rates.

But that still leaves high food or CPI inflation, which is what really affects the general public. Some of it has to do with the erratic monsoon that has impacted this year’s kharif crop. But a larger share of the blame lies with policy failure, given that the main contributor to food inflation this time has been cereal prices. The fact that they are up by roughly a fifth over last year, despite public godowns holding nearly three times the necessary quantum of wheat and rice, reflects the Government’s sheer lack of ability to undertake effective market intervention. With the rabi crop prospects looking good as of now, there should be hopefully some respite in food inflation from the next month onwards. But in any case, there is not much that monetary policy can do on this front. What it can do at best is prevent wage pressures from high food prices getting transmitted to the rest of the economy. In the current situation, however, producers have little scope to resort to price hikes, thus rendering the RBI’s recourse to a hawkish monetary policy stance redundant.

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