The new RBI Governor has made it amply clear by now that his priority would lie in fighting inflation, unlike his predecessor who chose to walk through the delicate balance between growth and price concerns and ended up losing at both the fronts. Under his leadership, RBI is mustering all its resolve to regain control over inflation, even if it entails raising policy rate by a few notches and hurting growth in the short run. In a recent interaction with the Governor, many market analysts supported this view as they felt underlying inflationary momentum across sectors has picked up in recent months. If that is so then Governor Raghuram Rajan has an easy choice on October 31 as both WPI and new CPI headline inflation numbers have picked up in September, somewhat in line with its own projection made, on September 20, in the mid-quarter review.
Is the choice going to be that easy given the economy is decelerating fast, quarter-on-quarter? Is the level of repo rate low enough to warrant a hike? According to many market analysts the answer is an unequivocal yes, as they focus more on the new CPI inflation. For RBI though, it still remains an uncharted territory. Caught between wide divergence between the WPI and CPI inflation, RBI is treading carefully.
For the central bank, matters get more complicated as core-CPI inflation remains stickily high in a 8.2%-8.6% range barring a couple of months, a feature contrary to what one would expect in six straight quarters of below-trend growth; the disinflationary feedback, by contrast, is clearly visible from down-trending WPI inflation for over a year as weakening demand filters through. The CPI’s limited history precludes informational insights on its linkages with other macroeconomic variables, a serious constraint for monetary policy adjusting to retail price inflation as a first. The context is delicate, the backdrop wary and stakes high. Can history offer some perspective?
It’s important to understand why the larger focus upon CPI inflation vis-ŕ-vis WPI inflation in recent times. This is quite new, going back about two years. Its genesis lies in the failure of RBI to tame inflation, raging since 2009-10. Headline WPI inflation averaged 9.8% monthly in 2010 and 2011, with retail inflation (as per the CPI-IW index) a percentage point higher. Crucially however, CPI inflation averaged 11% monthly from October 2008 to end-2009, peaking at 16.2% peak in January 2010.
Monetary policy, in