Tears from onions

Persistent food inflation constrains monetary policy

Inflation just refuses to subside. The September numbers for both the wholesale price index (WPI) and the consumer price index (CPI), which were released on Monday, indicate that it has risen somewhat from its levels for August. WPI inflation in September clocked 6.46 per cent, up from 6.1 per cent in the previous month, while CPI inflation came in at 9.84 per cent, up from 9.52 per cent in the previous month. Since these are the last readings before the second-quarter review of monetary policy, scheduled for October 29, the rise in both indices may have implications for policy actions by the Reserve Bank of India (RBI).

Beneath the headlines, though, the numbers reveal the enormous pressure that is being currently exerted by food prices. WPI food inflation was above 18 per cent; this despite the monsoons having performed extremely well. Over the past several months, the drivers of food inflation have changed. Proteins have given way to cereals, particularly rice, which saw its wholesale price rise by almost 19 per cent. But the outstanding contributor was onions, which saw a year-on-year price increase of 322 per cent. It is striking that high onion prices have persisted for several weeks now, in contrast to the relatively short-lived surges seen in other recent episodes. This increase saw the prices of the vegetables group increase by almost 90 per cent. On the other hand, the increase in the prices of manufactured goods, roughly approximating core inflation as defined by the RBI, was a mere two per cent, reinforcing the picture of a significant slowdown in the sector, which has eroded the pricing power of producers. In contrast, while the aggregate CPI numbers also indicate an acceleration in inflation, the composition appears to be quite different. Food and beverages prices in this index rose by a little over 11 per cent in September; within this group, vegetable prices rose by a relatively moderate 35 per cent. However, the "clothing, bedding and footwear" group, in a sense representing manufactured goods in the CPI basket, saw prices increase by over nine per cent. In other words, while the WPI numbers suggest that demand-side pressures are virtually non-existent, the broader inflationary pattern in the CPI challenges that perception.

These patterns exacerbate the dilemma that the RBI will have to resolve. Given that it hiked the repo rate in September, it is very unlikely to reverse course so soon. At best, it can use the relatively muted core inflation reading to justify status quo on the repo rate, while continuing to roll back on the marginal standing facility (MSF) rate, thereby effecting some short-term loosening. On the other hand, with RBI Governor Raghuram Rajan's perceived preference for the CPI as the policy benchmark, the patterns from that index suggest that another hike in the repo rate may be on the cards. The rationale for this is unexceptionable; high headline inflation fuels expectations of further rises, resulting in self-fulfilling behaviour by workers and businesses. But, given the very visible role of food inflation in the story, whichever index is looked at, it is inconceivable that inflation will moderate without directly and aggressively addressing the supply constraints in this sector. The persistence of food inflation is seriously constraining the space for effective monetary policy.