Column: Has the dog begun to bark?

Jun 23 2014, 02:52 IST
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SummaryResurgent WPI-core inflation amidst signs of initial recovery raises question about falling potential output

The jump in May wholesale price inflation to 6% year-on-year from April’s 5.2%, and way above the consensus 5.3% estimate, is a nasty surprise. The spike comes from an across-the-board increase in primary products and manufactured goods’ prices. While food inflation wasn’t entirely unanticipated, it is the broad-based increase in core-inflation—an indicator of demand pressures—that causes disquiet. Specifically, core-WPI inflation rose 3.84% year-on-year, 59 bps higher than previous month with a sequential, seasonally-adjusted rate of 0.7%. Further, March’s headline inflation was revised up 30 bps to 6%; the final core inflation print was corrected by 52 bps, raising it to 4.03% from provisional 3.51%. Going by past trends, it would be reasonable to expect similar adjustments in the interim April-May data points.

What could these price developments portend? Has the inflation dog begun to bark once more? Or are these a temporary blip?

Markets did not react adversely to the inflation surprise. Private sector analysts appear to have veered to the conclusion this could be transient, preferring to wait for further developments for a clearer picture. Further, there isn’t as yet any clear association between WPI-core and new CPI-core and, therefore, it seemed prudent to wait further as their focus remains CPI inflation, on which monetary policy is now based.

The Reserve Bank of India (RBI) was, however, quick to react. The very next day, the Governor remarked that the next few quarters would be engaged in combating inflation. The comment aimed to recondition expectations formed earlier around its review statement less than a fortnight ago; these stated that a faster-than-anticipated disinflation, adjusting for base effects, would provide headroom for an easing of the policy stance and that “further policy tightening will not be warranted” if the economy stayed the course (of CPI inflation).

In the backdrop of a deficient rainfall forecast, the central bank has every reason to be concerned for the inflation shock may not be quite as insignificant. For one, the 6.01% inflation out-turn in May was 70 bps higher than the consensus estimate (5.3%), which allows for any understatement or exaggeration of inflation rates from base abnormality. Add to this a 30 bps correction to the final print. The total shock could be as much as 100 bps or a full percentage point increase. And that’s just the headline WPI-inflation rate. Core inflation, which is more relevant from a business-cycle perspective, has been adjusted up 50 bps on average in

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