Will inflation rise or fall? Even RBI doesn't have a clue

Moneycontrol Bureau

If you are looking for clues as to whether inflation will rise or fall in the coming months, the Reserve Bank of India's monetary policy statement may not be of much help.

There are far too many contradictory statements on inflation, even though the central bank has upped its target reading for the current financial year to 7.5% from 7% earlier.

As RBI has rightly pointed out, there are far too many factors at play simultaneously that goes into shaping inflation. That being the case, the central bank can be forgiven for being as clueless about it as the man on the street is.

RBI sees inflation climbing in the current quarter as the government cuts back on subsidies to reduce fiscal deficit. However, it sees inflation trending lower next quarter.

These two paragraphs best tell you why it is next to impossible for RBI to get a handle on inflation.

"On the downside, slower growth and excess capacity in some sectors will help moderate core inflation. Stable, or in the best case scenario, declining commodity prices will reinforce this tendency. An appreciating rupee will also help to contain inflationary pressures by bringing down the rupee cost of imports, especially of commodities."

But:

"On the upside, persistent supply constraints may be aggravated as demand revives, resulting in price pressures. Rupee depreciation, which may result from global financial instability, will add to imported inflation. An important driver of inflation is the upsurge in both rural and urban wages, which is exerting cost-push pressures. Finally, as under-pricing in several products is corrected as part of the fiscal consolidation process, suppressed inflation is being brought into the open and will result in higher inflation readings."

What the RBI has left unsaid here is that unless the supply side problems are fixed, any revival in demand could turn out to be counterproductive. Also, the RBI has clearly stated it is bearish on the global economy, and feels loose monetary policies by central banks in the US and Europe could drive up commodity prices.

And then there is the problem of food inflation, caused by a combination of local and global factors.

"The uneven temporal and spatial distribution of the monsoon this year is expected to adversely impact the Kharif output. According to the first advance estimates, production of Kharif foodgrains will be lower by 9.8 per cent over last year.

Drought conditions in important foodgrain producing areas of the world are likely to impart an upside and persistent bias to international food prices with adverse implications for all countries that have relatively high weights for food in their inflation indicators. The behaviour of food inflation will also depend on the supply response in respect of those commodities characterised by structural imbalances, particularly protein items.”

And yet, the RBI is betting on inflation easing going forward, as can be seen from this line.

 "As inflation eases further, there will be an opportunity for monetary policy to act in conjunction with fiscal and other measures to mitigate the growth risks and take the economy to a sustained higher growth trajectory."