Vegetables responsible for most of fall in inflation
With wholesale price inflation falling to a 9-month low in February and consumer price inflation at a 2-year low, it’s tempting to think the recent spate of rate hikes have begun to do the trick. For one, rate hikes take 9 to 12 months to have an impact. Two, most of the recent fall in inflation is driven by one thing: vegetables. It was the rise in vegetable prices that led to the surge in inflation, especially at the level of consumer prices, and it is the collapse of that vegetable inflation that has resulted in overall CPI/WPI falling to more manageable levels.
In the case of CPI, headline inflation has fallen a whopping 300 bps, from 11.2% in November 2013 to 8.1% in February 2014. But what is interesting is that vegetable inflation fell from 61.1% to 14% in the same period. Given the 5.4% weight of vegetables in the CPI, this decline alone means a fall in overall CPI by 2.54 percentage points—that is, around 83% of the overall decline in the headline CPI during this period was on account of vegetable prices that no one can argue are influenced by monetary policy. In the case of WPI, where headline inflation also collapsed as dramatically, from 7.52% in November 2013 to 4.68% in February 2014, inflation for vegetables fell from 97.7% to 4% in the same period. Given the 1.7% weight of vegetables in WPI, this alone resulted in a fall of 1.59 percentage points, or 55% of the total reduction in headline WPI. Core CPI, by contrast, remained at 7.9-8% during this period, as did core WPI at 3-3.1%.
Given the havoc created by the recent unseasonal rains, and the possibility of an El Nino impact on the monsoons, it is likely that fruits and vegetable inflation will once again rise. In such a situation, it is important that RBI keep in mind the difference between inflation that can be influenced by monetary policy and that part which cannot. Not keeping this in mind and, instead, adopting the Urjit Patel inflation-targeting recommendation—with a CPI target of 6% over two years—will lead to a situation in which RBI will have to jack up rates so much, the rest of the economy will suffer. As credit-rating agency Crisil’s chief economist, DK Joshi, points out, if food inflation is to stay at its 10% average for the last 8 years, a 6% CPI inflation target means non-food inflation has to come down to 2%. For a 4% target—Patel’s long-term target—this has to come down to minus 2%.