An increasing disconnect

Slower growth is not impacting consumer price inflation

The numbers for December's index of industrial production (IIP) and January's consumer price index (CPI) were simultaneously released on Wednesday. The former generally lived up to expectations, showing a decline of 0.6 per cent year on year. The latter, in contrast, surprised positively, showing overall inflation at 8.8 per cent, consequent on a sharp decline in food inflation, which came in at 9.9 per cent, a sharp break from the past several months. This was mainly due to the deceleration in vegetable prices, which grew by a relatively low 22 per cent. However, core inflation - that is, inflation excluding food and energy prices - was still above eight per cent, a level below which it has stubbornly refused to fall despite so many months of very sluggish growth.

As regards the IIP, the number is largely consistent with the pattern seen over the past several months. December's decline takes the April-December performance into negative territory. Whether this is eventually borne out by more reliable numbers later, there is no disputing the fact that the industrial sector has been in a prolonged slump, with really no forces of recovery visible anywhere. The one possible source of comfort is the continuing strong performance of garments, which grew by almost 20 per cent year on year, taking their performance for 2013-14 so far to above 30 per cent. This might reflect the positive effects of a sharply depreciated rupee, making this very important sector significantly more competitive. However, this enthusiasm, as in so many months before, must be tempered by the fact that the growth in textile production is below four per cent! Several other major industrial groups, particularly in the capital goods sector, have shown declines, all reinforcing the impression of an investment drought. But consumption spending appears to be reinforcing this negative pressure; consumer goods declined by over five per cent year on year, mostly because consumer durables fell by more than 16 per cent, taking their year-to-date decline to 12.6 per cent. No cylinders appear to be firing for the industrial sector.

The real story in these numbers is the persistent disconnect between the growth and inflation patterns. The Reserve Bank of India's (RBI's) rationale for its monetary policy stance has been that it is important to bring down inflation even if this comes at the cost of growth, because this is a short-term cost that yields significant long-term benefits. This is all very well, but this argument begins to break down when the slower growth does not seem to have any impact on consumer inflation. The obduracy of core consumer inflation is a mystery that is imperative for the RBI to solve as it transits to a new, CPI-benchmarked policy framework. Inflation targeting, or any targeting for that matter, only works when there is a clear and relatively quick linkage between instruments and targets. If even the core CPI does not demonstrate such a linkage, does the index make for a practical target? One explanation for the disconnect is the huge impact of food prices on wages, which feed directly into the prices of services. If this is the case, it is all the more important to contain food inflation as quickly as possible. Same old story.