The bumps ahead

Assessing inflation risk in the time of spiking prices and damp consumer sentiment

For an economy that relies on public investment and private consumption to revive private investment and growth, the last round of official statistics on prices and industrial activity signal testing times ahead. First, industrial output plummeted by 0.4% in December 2016, led by a 2% decline in manufacturing (just five of 22 industries registered positive growth) and a 6.8% decline in consumer goods. Now, wholesale prices have risen at the fastest pace in two and a half years this January, at 5.25%. This is particularly noteworthy since the pace of price rise at the consumer level slowed to 3.2% in the same month. By contrast, consumer prices had risen fractionally faster (3.4%) than wholesale prices (3.39%) in December. This divergence in wholesale prices and the prices consumers pay is unlikely to last long — with the former expected to stay firm for a few months to come, the latter will eventually catch up. The Reserve Bank of India may no longer track wholesale prices for monetary policy purposes, and food prices are not a problem thanks to a normal monsoon, at least for now. But as RBI Governor Urjit Patel pointed out, consumer prices of non-food articles and fuel have been hard to contain since September 2016. Such sticky core inflation is driving the latest wholesale price surge with fuel and power rising a sharp 18.14%, manufactured products growing by almost 4% (thanks not to demand but upward commodity prices) and minerals by 1%.

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A rise in oil prices beyond $65 a barrel would be a cause for concern, as Finance Minister Arun Jaitley has said in his recent Budget , even if there is a belief that higher shale gas output will check a further spike. This poses a risk to the Centre’s fiscal arithmetic as well as India’s growth hopes. Higher oil price-led inflation will bring back into focus the high excise duties on petroleum products that have boosted the Centre’s tax kitty over the past couple of years. Those duties were raised when prices were low to protect consumers from an upward price shock, the government had argued. Cutting those duties will upset revenue calculations, but leaving them untouched will impose its own costs. The RBI has cited ‘transitory effects of demonetisation on inflation and output’ as the rationale to hold interest rates and shift from an accommodative monetary stance to ‘neutral’. It is unlikely to ease its stance unless it sees executive action against inflation risks. Secondly, consumer sentiment that held up during the November 8 to December 30 demonetisation period has been declining since January, as per CMIE data. If inflation spikes in the coming months, it could further crimp consumer spending, with obvious consequences for the investment cycle and job creation.