A mass of jumbled signals

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SummaryShould RBI assign an inflation risk premium or discount to the policy rate?

“It is important to break the spiral of rising price pressures in order to curb the erosion of financial saving and strengthen the foundations of growth … both wholesale and consumer price inflation are likely to remain elevated in the months ahead, warranting an appropriate policy response … It is in this context that the LAF repo rate has been increased by 25 basis points.”

RBI’s monetary policy stance is clearly loaded towards fighting inflation, with other objectives now secondary. But there are many puzzling, if not contradictory, signals on the growth-inflation dynamics. In setting the policy rate, given the noise and inadequacy of economic data, should RBI pitch the rate above or below what the more data rich decision might warrant?

The key question is how, despite increasing signs of steadily faltering growth, can inflation, particularly retail inflation, remain so persistently high? Saying that retail inflation is due to food and stems from structural bottlenecks is not completely satisfactory. While food inflation has indeed been higher than the other components of the CPI basket, and fuel price driven transport costs increases are logical, inflation in segments like clothes, home rentals, medical care, education all remain in high single digits, and the “other miscellaneous” segment in double digits.

If growth were indeed slowing, so would salary and wage increases, leading to tapering of disposable income; and concerns of potential job loss leading to reduction in discretionary spending and propensity to spend, which is at odds with observed segmental inflation. If households were spending more on food, fuel and transport, given a presumed lack of income growth, should not discretionary spends, and hence pricing power, come down? So, the obvious question is: has growth really slowed as the data seems to suggest? Or is there some other source of income which is not getting captured in the data?

For RBI, this quandary must be clear and present. The experience of the sharp upward revision of the FY11 GDP numbers two years down the line, with earlier monetary policy having been calibrated to the lower figure, must weigh heavily on current RBI thinking. So might actual growth now be higher than the 5% projected by government bodies and the 4.5% projected by other analysts? Are the IIP statistics, for instance, adequately capturing activities of the unregistered sector, even if not in the initial estimates, at least in the revised ones?

One indication of this is to compare

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