RBI's fears on inflation may not play out

A shock unlikely even if prices of vegetables and pulses go up

For the seventh consecutive month now, the wholesale price index (WPI) has contracted. The WPI in May has contracted 2.36 per cent, suggesting the economy continues to be in deflation mode. In April, WPI had contracted 2.7 per cent. All the major constituents of WPI— primary articles, manufactured goods and fuel & power— continue to show contraction.

While the year-on-year fall in commodity prices explains the continued contraction in prices of manufactured products and fuel, the fall in primary articles was largely led by non-food articles. Food prices inched up 3.8 per cent in May due to an increase in prices of pulses, onions and fruits. Despite this, economists believe food prices are not showing any alarming trends and have continued to decline since January.

Given the Reserve Bank of India (RBI) only looks at consumer price index (CPI), most would dismiss the continued contraction in WPI. But the CPI data is not showing any divergence from the WPI, even though it inched up to 5.01 per cent in May from 4.87 per cent in April.

Soumya Kanti Ghosh, chief economic adviser at State Bank of India, says the revised CPI numbers released by the government on February 2015 include unseasonal items such as tomato, cauliflower, peas and grapes. These items are not included in the WPI; if one excludes the unseasonal items, the CPI is overstated by 25 basis points. At the state level, a large part of the food inflation is fuelled by potato and onion prices.

Food prices, other than pulses and select vegetables, are largely showing a benign trend. After contracting for eight months, vegetable prices rose by 1.7 per cent while prices of pulses jumped 4.6 per cent. Also, monsoon trend so far shows that Central India, which produces pulses, has received 12 per cent excess rainfall. Kotak Economic Research is factoring in some upside in vegetables, pulses and oilseeds given the weather forecast, but it does not yet expect a generalised food price shock. Additionally, the service tax rate of 14 per cent from earlier 12.36 per cent would marginally push up core inflation in June, but prices are largely expected to remain stable.

Economists do not share RBI's concerns on prices and believe inflation will undershoot the central bank’s estimated CPI level of six per cent by March 2016. Therefore, further rate cuts are now being ruled out. If inflation continues its downward trajectory, RBI will need a credible reason not to cut interest rates. The US Fed’s rate cycle is set to turn later this year, but India is in a much better position than it was in 2013.