Economic Survey 2016: Retail inflation likely to remain at 4.5-5% in coming fiscal

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New Delhi | February 27, 2016 12:52 AM

Retail inflation will likely remain in the 4.5-5% range in the coming fiscal, within the central bank’s target of 5% by March 2017, despite an expected spiral in wage costs...

Retail inflation will likely remain in the 4.5-5% range in the coming fiscal, within the central bank’s target of 5% by March 2017, despite an expected spiral in wage costs following the implementation of the 7th Pay Commission’s (PC) recommendations, the Economic Survey said on Friday. This leaves the room for the monetary policy to be relaxed in 2016-17, it said.

Already, retail inflation dropped to 4.9% during the April-January period, against 5.9% a year before.

Citing the subdued impact of the 6th PC on inflation despite higher wages (CPI-IW inflation remained around 7% for almost a year in 2008 when the government started to implement the last PC recommendations), the Survey argued that the effect of the current PC suggestions on inflation would also be minimal, as the expected wage bill (including the railways’) will go up by around 52% under the 7th PC, against 70% under the last pay penel.

This is because pay awards determine only a tiny part of aggregate demand and since the government is committed to reducing the fiscal deficit, the pressure on prices will diminish. However, it admitted that a sharp increase in public sector wages could affect inflation if it spilled over into private sector wages and hence private sector demand.

“But currently, this channel is muted, since there is considerable slack in the private sector labour market, as evident in the softness of rural wages,” it said.

Even if private sector wage increases, the existence of substantial capacity underutilisation suggests that companies might find it difficult to pass the cost increase onto consumer prices. However, there could be some mechanical impact of the increase in the house rent allowance on the housing component of the CPI. But this effect is likely to be modest between 0.15 and 0.3 percentage points.

Moreover, another year of below-par growth could help widen the output gap (reflected for example in the declining capacity utilisation), which will add to downward pressure on underlying inflation, which has already fallen
below 5%.

If the monsoon turns out to be normal after two straight years of remaining below par, food prices could ease, especially since the government remains committed to disciplined increases in MSPs for cereals, and rural wage growth remains muted.

The continued uncertainty over China’s economic woes, an expected rise in Iranian crude supply and a moderation in demand from the rest of the world will likely keep crude prices subdued in the near future.

Stressing that the situation calls for further relaxation of monetary stance, the Survey said: “Indeed, with the current stance, there is a possibility of undershooting… We therefore think that the effective stance of monetary policy could be relaxed and in two ways. First, by easing liquidity conditions to make them consistent with the current policy rate. Second, by further lowering the policy rate consistent with meeting the inflation target while supporting weakening economic activity and corporate balance sheets,” it said.

What’s in store
* Retail inflation will likely remain within the central bank’s target of 5% by March 2017, despite an expected spiral in wage costs following the implementation of the 7th Pay Commission’s recommendations. This leaves the room for the monetary policy to be relaxed in 2016-17
* Already, retail inflation dropped to 4.9% during the April-January period, against 5.9% a year before
* Citing the subdued impact of the 6th pay panel on inflation despite higher wages, the Survey argued that the effect of the current pay panel suggestions would also be minimal

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