Sustained price pressures on food articles

The Reserve Bank of India continues to monitor full array of price indices

In view of the divergent movement of various price indices and their components an assessment of underlying inflation for policy purposes becomes inherently complex.

Inflation and inflationary pressures are major areas of concern for central bankers world over. In India, the Reserve Bank of India (RBI) was very cautious in its approach to present inflation rates, which decelerated from a projected 7 per cent (by end-March 2009) in the mid-term review of the monetary policy of 2008-09 to below 3 per cent by end-March 2009.

“A sharp fall in inflation is alarming,” said D. Subbarao while announcing the central bank’s review of its third quarter Monetary Policy 2008-09. Pointing out that lot of uncertainty is prevailing in inflation numbers Dr. Subbarao said that the current assessment of inflation in India is complex. Headline inflation, as measured by year-on-year variations in the wholesale price index (WPI), fell by more than half from its intra-year peak of 12.91 per cent on August 2, 2008, to 5.60 per cent by January 10, 2009.

While prices of primary articles and manufactured products increased, fuel prices declined.

In terms of relative contribution to decelerating headline inflation between August 2, 2008, and January 10, 2009, petroleum and basic metals (combined weight of 13.2 per cent in WPI) together accounted for 79.4 per cent followed by oilseeds, edible oils and oil cakes (16.4 per cent). Clearly, the fall in commodity prices, reflecting global trends, has been the key driver of the sharp fall in WPI inflation although effective management of domestic demand too has contributed to this moderation.

On the other hand, inflation, based on various consumer price indices (CPIs), is still in double digits due to the firm trend in prices of food articles and the higher weight of food articles in measures of consumer price inflation. As the decline in input prices percolates over time to the prices of manufactured and other products, consumer price inflation too is expected to soften in the months ahead. For its overall assessment of inflation outlook for policy purposes, the RBI continues to monitor the full array of price indices.Pressures on commodity prices have abated markedly around the world, reflecting a slump in global demand. The sharp decline in crude oil prices together with the slide in prices of metals, foodgrains and cement has influenced inflation expectations in most part of the world.

While prices of manufactured products and of the fuel group have declined in line with international trends, inflation on account of primary articles still remains at the double digit level, reflecting sustained price pressures, particularly on food articles. As per current assessment, the inflation rate is expected to moderate further in the last quarter of 2008-09. “Keeping in view the global trend in commodity prices and the domestic demand-supply balance, WPI inflation is now projected to decelerate to below 3 per cent by end-March 2009”.

The divergence

Notwithstanding the projected decline in headline WPI inflation, it needs to be noted that consumer price inflation is yet to moderate and the decline in inflation expectations has not been commensurate with the sharp fall in WPI inflation. Even within aggregate WPI inflation, primary articles inflation is still in double digits. Similarly, WPI inflation, excluding food and fuel, remains higher this year compared with the previous year.

In view of the divergent movement of various price indices and their components, and overall increase in global economic uncertainties, an assessment of underlying inflation for policy purposes becomes inherently complex. With WPI inflation having moderated significantly, consumer price inflation would also decline, though with a lag. Towards its policy endeavour of ensuring price stability with well anchored inflation expectations, the RBI will take into account the behaviour of all the price indices and their components.

The conduct of monetary policy would continue to condition and contain the perception of inflation in the range of 4-4.5 per cent so that an inflation rate of around 3 per cent becomes the medium-term objective, consistent with India’s broader integration into global economy and with the goal of maintaining self-accelerating growth over the medium-term.

However, it is recognised that the headline WPI inflation could fall well below 3 per cent in the short-run — partly because of the statistical reason of high base, and the global trends caused by exceptionally high oil and commodity prices in early 2008 — while the interpretation of inflation remains a complex matter.

Interest rate

The Reserve Bank’s explanation — on complexity in inflation numbers — would be considered as one of the cardinal factors for the central bank to take a well thoughtful decision not to reduce the key indicative rates (lending as well as deposit) and kept these rates unchanged unlike many economists and bankers were expecting.

Interest rates in the money and bond markets have already declined perceptibly since their peaks in October 2008.

Major public sector banks have also reduced their term deposit rates in the range of 50-150 basis points. Benchmark prime lending rates (BPLRs) of major public sector banks have come down by 150-175 basis points. Major private sector banks have reduced their BPLRs by 50 basis points, while major foreign banks are yet to do so.

Many banks, especially private and foreign banks, would be in a hurry to increase their lending rates when the central bank increases the key indicative rates. But when the central bank reduces its rates these banks fail to translate it into their respective rates. The Reserve Bank says: “As a result of several measures initiated by the Reserve Bank since mid-September 2008, banks’ cost of funds would come down. This should encourage banks to reduce their lending rates in the coming months”.

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