Fait accompli

High inflation will likely force RBI to raise rates

If there were any doubts about the resurgence of inflationary pressures in the economy, the November numbers for the wholesale price index (WPI) dispelled them decisively. The year-on-year inflation rate surged to 7.5 per cent, compared to the October reading of seven per cent. Over the past few months, the pressure from food prices has intensified and this shows up starkly in the November readings. Strikingly, rice is a big contributor, with its prices having risen by about 15 per cent year on year, a pattern that has become entrenched over the past several months. The tears caused by onion prices still remain; prices went up by under 200 per cent year on year in November. Among other food items, while the prices of pulses have been softening considerably over the past few months, further declining by over 10 per cent in November, eggs, meat and fish registered a price increase of more than 15 per cent. Energy prices were also a significant contributor to the inflationary momentum, with overall prices rising by over 11 per cent year on year and those of diesel rising by more than 15 per cent. This is not a bad thing, in view of the fact that it is still significantly underpriced. But, more broadly, the lower rupee has clearly added to the energy bill in rupee terms, with the inevitable consequences for inflation.

In sharp contrast, the prices of manufactured goods rose by a modest 2.6 per cent, more or less in line with the pattern seen over the past six months. Evidently, neither higher food prices, which could have a bearing on the cost of labour, nor higher energy prices are showing much of a pass-through into the prices of manufactured goods. This clearly reflects the absence of pricing power in this sector and the consequent pressure on producers to absorb higher input costs through lower margins. In this context, a significant disconnect appears to be emerging between the consumer price index (CPI) and the WPI. The former shows a significantly higher rate of inflation than the latter when food and energy are excluded. This could have an important bearing on monetary policy decisions and must be explained and clarified as soon as possible.

Coming to policy decisions - the next of which is due on Wednesday - Reserve Bank of India Governor Raghuram Rajan has already made it clear that inflation control will be his priority and that he will attach significant weight to the CPI. These numbers do not seem to make enough of a case to deviate from the path that he started going down with a repo rate increase in September. Thus, the only decision that is consistent with both last week's CPI numbers and Monday's WPI numbers is another rate hike. The government has failed to address the enormous structural problems in agriculture. The result has been to completely tie the Reserve Bank of India's hands in a damned-if-you-do, damned-if-you-don't knot. And there is no obvious way to unravel it.