Index has little connection with the real economy
Given how October CPI inflation has gone back to over 10%, chances are RBI Governor Raghuram Rajan will once again hike repo rates, something many economists have been arguing for—indeed, these economists point to how even the WPI has begun to trend up again. The WPI trending up, though, needs to be put in perspective since it was up to 6.46% in September from 6.10 in August—in September 2012, however, it was 8.07% and it was 10% in September 2011; manufacturing WPI was a mere 2.03% in September 2013 compared to 6.47% in September 2012 and 8% in September 2011. Over the longer term, WPI has been trending downwards along with other indicators like GDP and IIP, something you would expect from any normal indicator in any normal economy. The CPI, however, shows little correlation with other economic variables. Since the index is less than three years old, this could be passed off as a statistical quirk, a data-collection model that needs some tweaking—but with RBI putting out its first-ever CPI forecast and statement that “retail inflation is likely to remain around or even above 9 per cent in the months ahead, absent policy action”, it is apparent CPI is very much on RBI’s policy radar. This is much the same as it is in many developed economies, but the CPI there is more robust and RBI needs to look at other growth parameters as well, more so since inflation-targeting as the main policy objective was given up by most central banks a long time ago.
More critical, what is driving up both WPI and CPI inflation the most are prices of food articles, particularly cereals, milk and vegetables—in October, had vegetable inflation remained at September’s 35% instead of rising to 45%, overall CPI would have been 0.54ppt lower than the headline number; in other words, it would have fallen instead of rising. Though it is true, as Governor Rajan pointed out in his media interactions after the last policy, that repo rates are not aimed at controlling food prices, food inflation is going to keep rising—so any policy that focuses primarily, or largely, on CPI is going to be one that keeps raising rates till economic growth gets choked off. And the reason why CPI in fruits and vegetables will keep rising is that the supply situation lags hugely behind the demand side—between just FY10 and FY12, for instance, while per capita incomes grew a third, supplies of fruits rose just 5.3% and vegetables 12.6%. To be fair, the government must share a large part of the blame for this since, by not freeing up farmers from trader-controlled mandis—this ensures they don’t get the larger part of the price upside—and by bringing in a Food Security Act that tilts the benefits in favour of more production of wheat and rice, it is ensuring the supply of milk, fruits and vegetables will lag demand by a huge margin.