January inflation: Nothing to cheer despite fall

India’s annual rate of inflation for the month of January fell to a 25-month low of 6.55 per cent, giving fresh life to calls for an interest rate cut by the Reserve Bank of India.

Food inflation, which has a weightage of about 14 per cent in the Wholesale Price Index (WPI) fell to 2.25 per cent from 3.07 per cent in December 2011, primarily because of a good harvest for most food articles and a consequent drop in prices. 

Core inflation, or non-food manufacturing inflation declined to 6.49 per cent from 7.44 per cent.

But we tell you why there is nothing to cheer despite the fall in inflation.

*One of the key contributors to inflation is the fuel price since it is a critical component of all economic activity – agricultural or manufacturing. Brent crude remains in the over $100 a barrel mark, which means that deregulation of fuels such as diesel, kerosene and LPG is unlikely.

Administered fuel prices put more pressure on government finances, which leads to more inflation. If they are deregulated like petrol, and tied to market prices, they will cost more, again leading to higher inflation.

*The WPI numbers should be taken with a pinch of salt. The perception of people who actually have to live with inflation is very different. A survey of urban households – which have to deal with real prices – released by the Reserve Bank of India on Monday, shows that they expect inflation to remain as high as 13.3 per cent for December 2012. According to the inflation Expectations Survey of Households: December 2011 (Round 26)', the rise is anticipated to be mainly on account of movement in food prices.

While housewives expect inflation to stand at 13.7 per cent in December, 2012, daily wage workers said it would be 13.8 per cent. While 96.8 per cent respondents said they expect food prices to rise during 2012, 96.2 per cent had a similar opinion regarding price rise of non-food items.

*Earlier this month, advance GDP estimates from the government showed economic growth slowing to 6.47 per cent for the fiscal year ending March 2012. Key employment sectors, such as agriculture and manufacturing, are also lower than earlier numbers. Combined with a tenuous financial situation in the Eurozone, and struggling agriculture and manufacturing at home, don’t expect economic growth to pick up in a hurry. So while lower inflation might be a good thing, it is not necessarily a sign of a better economy.

*The fiscal budget is already stressed almost to a breaking point. It is estimated to overshoot the 4.6 per cent projection by at least Rs 1 trillion. If it overshoots its target, that would be a recipe for higher inflation going forward since the government will have borrowed from the RBI. Also, it remains to be seen what kind of deficit is targeted in the new budget in March. If the deficit target is raised that will not help inflation since the government would have to borrow more money which will eventually find its way into the system, stoking inflation.

*RBI is one of the most conservative central banks in the world today. It is unlikely to cut interest rates in large chunks. The apex bank has hiked its key-policy rates 13 times between March, 2010, and October, 2011, by a total of 350 basis points to curb inflation. So it is highly unlikely that it will resort to cuts in policy rates that could stake inflation. Instead, expect a very gradual easing off of monetary policy, depending solely on the given prevailing situation – not sentiment – at that time.