The stickiness of ‘core’ inflation, the minutes of the Monetary Policy Committee (MPC) make clear, is the main reason for RBI changing its monetary policy stance from ‘accommodative’ to ‘neutral’, and that is why the consensus is there will be no more rate-cuts in the next three-six months at least, unless there is a dramatic fall in core inflation levels. Not surprisingly, the moment RBI announced its policy, and all members of the MPC gave the same sticky-core-inflation as the reason for changing the monetary policy stance, bond markets collapsed, along with hopes that more rate-cuts were in the offing.
Two recent analyses, however, point in the same direction, of the central bank measuring ‘core’ inflation incorrectly and, not surprisingly, coming to the wrong conclusion. That ‘core’ inflation should be falling also sounds intuitively correct since the high levels of excess capacity in the system would logically be acting as a check on inflation.
According to Bank of America-Merrill Lynch’s (BofAML’s) India Economist Indranil Sen Gupta, part of the confusion in measuring ‘core’ inflation ‘arises as petrol and diesel are split into two heads under the CPI: the non-transportation portion in Fuel and Light and the transportation part in Transportation’. BofAML excludes petrol and diesel in both the segments to arrive at the correct ‘core’ inflation, and finds that it has fallen to 4.5% in January 2017, from 4.6% the month before and 4.9% in July 2016. In other words, the BofAML analysis shows core inflation is actually coming off—if India’s growth is below potential, as it is, this is natural; how much growth is below-potential depends on whether you believe the current 7% GDP growth rate represents the same underlying activity as under the old GDP series.
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A similar conclusion has been reached by this newspaper’s contributing editor Surjit S Bhalla. Bhalla talks of a ‘false Indian core’ which, since it does not exclude petrol, is ‘closely aligned with twists and turns in petrol price inflation’—Bhalla provides a chart going back to 2014 in his column (“Jaywalking at RBI”, February 25, goo.gl/WgWJFL) to support the hypothesis. ‘True core’ inflation that strips this out, according to Bhalla, is seen to be ‘on a declining trend and at the lowest level since the new CPI series started in 2011’—Bhalla’s ‘true core’ inflation is 4.7% in January 2017, not too different from Sen Gupta’s 4.5%.
Given how critical the points being made by two independent researchers, it is time the central bank re-examines how it calculates ‘core’ inflation since there can be no meaningful rate cut otherwise. It is only after interest rates are cut, along with the impact of the pay commission and the good monsoon, that demand levels can be expected to rise fast enough to exhaust some part of the existing unused capacity—only then can new investments be expected.