How will the inflation numbers impact RBI policy?

The essential question for India's central bank is not if but when and how

The October numbers for the Consumer Price Index (CPI) and the Wholesale Price Index (WPI) were released last week. Both show a significant moderation in inflation rates. CPI inflation was 5.5 per cent, almost a percentage point below last month's reading and the lowest in almost three years; the previous dip was really an aberration. Significantly, the rate of increase in food prices was 5.6 per cent, almost equal to the overall index, a proximity that has not been seen for several years. The only food items showing persistent price pressure are milk and fruit, which clocked about 11 per cent and 17 per cent respectively. Cereals and vegetables, which contributed significantly to the trend over the past couple of years, were muted at six per cent and -1.5 per cent respectively. The most significant implication of these patterns is that the threat posed by an inadequate monsoon has proved to be unfounded. Two factors could have been at work here. One, the government sold significant amounts of rice and wheat from its stocks into the open market. Two, with a late recovery in the monsoon, farmers grew more vegetables, which are typically short-cycle crops. The latter may, thus, be a one-time phenomenon, but the former will have a lasting impact on price expectations and, through them, on crop choices.

WPI inflation came in at 1.77 per cent, the lowest in over five years and about 70 basis points below last month's reading. The drivers of this indicator are different than those of consumer inflation. The main reason for the sharp drop in wholesale inflation is the overall softening of global commodity prices. Oil has clearly been the most dramatic of these over the past two months, but other commodities have also seen an unmistakable downshift. The October fuel index was over a percentage point lower than it was in September; however, the correction in diesel prices over the course of the year took the fuel index to 0.4 per cent over last October. The prices of manufactured goods rose by about 2.4 per cent year-on-year, only somewhat lower than the 2.8 per cent recorded last October. This suggests that producers had, by and large, run out of pricing power for a while. The significant easing of commodity prices will clearly contribute to widening operating margins and profitability at current price levels, a basic requirement for any revival in investment.

Observers are obviously trying to predict what these very favourable developments mean for monetary policy actions. The key consideration in deciding on whether or not to lower interest rates will be whether the food and commodity price trends are durable or not. On the food front, continuing open market operations combined with realistic procurement pricing should induce the agricultural sector to begin rebalancing its cropping patterns. On the commodities side of the equation, while there are still some analysts who see these developments as temporary, the weight of opinion is tilted towards further softening or, at worst, stabilisation. Lower oil prices will also help narrow the fiscal and current-account deficits; the former adds another argument in favour of monetary easing. The essential question before the Reserve Bank of India, then, is not whether to ease, but when to do it and at what pace.