SPONSORED BY

Auto Segment
Mutual Fund Segment
My Budget
Expert Speak
In Association With
 
Business Standard

T N Ninan: Wrong price target

Policy makers in industrialised economies shifted focus from headline inflation to the underlying inflation trends, or core inflation a long time ago

Related News

Policy makers in the moved away a long time ago from focusing on headline — reflected through the wholesale price index. They recognised that this is influenced by in food and — as India is discovering. So policy makers shifted focus to the underlying inflation trends, or core inflation. The wisdom of this is now evident in India; the regular headlines on (a cumulative price increase of over 40 per cent in the last two years) serve to highlight the stress on household budgets, but there is little that the government can do about onion and vegetable prices if farmers do not respond to the incentive provided by higher prices and produce more. Macro-economic policy has to focus on the underlying inflation trends, yet there is hardly any attention given to this in even the business press.

Consider the inflation data for December. Wholesale price inflation was 8.4 per cent, with food prices up 13.5 per cent and fuel 11.2 per cent. Non-food manufactured items were up only 5.3 per cent. If that last number reflects India’s version of core inflation, the question to be asked is the Goldilocks question: is it too high, too low, or about right? But the question is not asked because the government and the Reserve Bank of India (RBI) continue to focus their forecasts on the over-all inflation rate. At this time last year, they were forecasting 5 per cent inflation by March 2010. That was not to be. Then the put out a target of 5.5 per cent for March 2011; it has now changed that to 7 per cent. But the forecast continues to be with regard to the headline inflation rate, which the RBI cannot control (did anyone anticipate Egypt, and its impact on oil prices?). Surely, it is time policy makers shifted their focus to core inflation.

Time for some perspective. The inflation rate in India over the past decade has averaged 5 per cent. The RBI would like that trend rate to drop to the 4-4.5 per cent range. If one assumes that long-term inflation in food and fuel will be more than in other items, core inflation would have to be about 3.5 to 4 per cent. So it would appear that the underlying inflation trend (at 5.3 per cent in December) was 1.3 percentage points too high, and the RBI is right to be tightening monetary policy.

But the manufacturing sector does not function in a vacuum. It is affected by rising prices of commodities, which are its raw materials. In an environment of sharply rising fuel and food prices, and of commodity prices in general, producers of manufactured goods will be forced to increase their prices too. Thus, car companies and producers of consumer non-durables announced price hikes recently. It is unreasonable, therefore, to expect core inflation to be 3.5 to 4 per cent when overall inflation is not 4 to 4.5 per cent. When wholesale prices are 4 percentage points higher than the ideal, is it unreasonable if core sector inflation is 1.3 percentage points higher than the preferred trend rate?

If the RBI aims to hit a 7 per cent headline number by March when oil and food prices continue to climb, as they did in January, the only way to achieve the target headline number would be through a really tight monetary policy and much higher interest rates that will shrink manufactured product inflation to no more than about 2 per cent. That will crimp demand with a vengeance and take away pricing power from producers. But is that what the country needs, or wants — especially when the impact on food and oil prices will be marginal?

Read more on:   
|
|
|
|
|
|
|

Read More

StatsGuru-25-February-13

The finance minister's balance sheet

Recommended for you

Most Popular Columns

Andy Mukherjee

Andy Mukherjee: Mr Modi's credibility test
Andy Mukherjee

Investor enthusiasm for Prime Minister Narendra Modi's policies is starting to wane, and only big-ticket reforms in the Budget can give it a boost

T N Ninan

T N Ninan: Suresh Prabhu, the Railway star
T N Ninan

Prabhu was the architect of the Electricity Act of 2003, which set the stage for reforms in the power sector. He could well end up transforming the railways

Anjuli Bhargava

Anjuli Bhargava: Air India and your old Ambassador car
Anjuli Bhargava

The national carrier has a host of ownership and legacy problems. Unless there are some changes, competitors will keep whizzing past

Advertisement

Columnists

T N Ninan

T N Ninan: Suresh Prabhu, the Railway star
T N Ninan

Prabhu was the architect of the Electricity Act of 2003, which set the stage for reforms in the power sector. He could well end up transforming ...

Akash Prakash

Akash Prakash: Manage your Budget expectations
Akash Prakash

A 1991-style big-bang Budget is not realistically likely - but here's the minimum that most investors expect to see

Shyamal Majumdar

Shyamal Majumdar: Half-truth at the Oscars
Shyamal Majumdar

Patricia Arquette did well with her 'gender tax' comment, but could have done better by advising what women can do for themselves to improve ...

Back to Top