Both the CPI and WPI inflation numbers for June, at 7.3% and 5.4%, respectively, have printed well below analyst consensus estimates and May data. Is this a sign that India has finally turned a corner in its sustained battle against inflation? The immediate implication is not just for the relief, however slight, for household budgets, but on more esoteric issues such as the stance of monetary policy and behavioural changes in household domestic financial savings, which are essential for financing growth.
The signals are mixed. First, the lower numbers still mask underlying price vulnerabilities. For instance, the 6% year-on-year drop in vegetable prices is, to an extent, due to the base effect of an increase in prices in 2013 (10% yoy in May 2013 to 15% in June). Vegetable prices inflation had accelerated massively in FY14, to 61% in November 2014 (with an average rate of 25% in FY14). This will naturally have a sharp decelerative effect on vegetable prices over the next few months in FY15, unless rains are significantly truant.
Led by vegetables, over the next 5-6 months, it is likely that base effects will result in a significant reduction in overall inflation. The first of the accompanying charts shows our best understanding of the inflation trajectory over the next couple of years, with the band estimating the projected range. The solid lines are projections of core (non-processed food manufacturing) in three scenarios. Of course, all of this is subject to much uncertainty; things can go either way, with global prices, weather volatility and other risks. But the probability of higher than projected inflation is likely to be higher than on the lower side. In addition, after a bounce back of inflation in early 2015, inflation is likely to stabilise in FY16 in the 6.5-7% range, with some potential for falling if measures to increase logistics efficiencies are put in place.
If we presume that price pressures are gradually mitigating, what might the proximate reasons be? For one, it has been widely recognised and agreed that the triumvirate of sharply higher MSP for crops (show in the second chart), rural wages and government subsidies and programmatic subventions have been largely responsible for higher inflation. Most of these drivers are stabilising, with the change moving to zero or even negative. This delta is the driver of inflation. While the immediate implication is that ceteris paribus inflation should be moving down to zero, other factors like improving capacities, more efficient agricultural markets and improved logistics should keep the impact of increasing incomes and demand more contained than before.
Not that price risks have abated. The threat of food shortages arising from deficient rains is still a possibility, even though the impact is projected by the MET to diminish over the next few days. Be that as it may, sowing is already much delayed in many parts of the country. A more structural driver is the increases in rural wages; data available till March show that the pace of growth is falling, but the reduction in the rate of growth over the past couple of years has been gradual. It is also a mystery what exactly is driving rural wages, since the metric itself is only the outcome of economic forces which are not very clear: a mix of changes in labour supply arising from government social safety programmes, increasing affluence from higher MSPs, remittance from urban areas, land sales, etc.
In addition to all this, the potential of core inflation beginning to creep up is strong, particularly in the short-term with growth-driven demand outstripping capacity. Global commodity prices are likely to support falling inflation, particularly if political volatility remains relatively contained.
The bottom line is that our understanding of the projections given above is still limited and, a significant part based on informal hypotheses. The connections and causal linkages to the fundamental drivers of demand and pricing are only partially understood. Even though the analysis based on the data (known to be) available at RBI are sure to be detailed, this will still be inadequate in formulating an effective, targeted and calibrated policy response. Deeper analysis, based on capturing and processing emerging and evolving behavioural and cognitive decisions of households, will be needed. This is where the role of big data analytics becomes central in policy response. This data is now increasingly collected in petabytes and more by various private market and household survey organisations, which are more granular and contemporary than official surveys. Many of the surveys also capture pricing adjuncts to quantity data, which are found only very imperfectly (if at all) in official data. A forthcoming CAFRAL workshop is likely to elaborate on this methodology, trends in which will be an exciting new analytics development.
Abhaysingh Chavan and Sanket Tandon contributed to this article
The author is senior vice-president & chief economist, Axis Bank.
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