Temporary reprieve

Inflation lower, but macroeconomic challenges remain serious

For a government under pressure because of the recent sharp rise in onion prices, the numbers for both the Wholesale Price Index (WPI) and the Consumer Price Index (CPI), published on Monday, should come as a relief. Inflation is noticeably lower on both indices compared with the previous month. On the WPI, headline inflation for June was 5.4 per cent, down from six per cent in May and the lowest number in four months. Food inflation was 8.1 per cent, significantly lower than the 9.5 per cent of May and appreciably below the rates over the previous three months. CPI inflation was 7.3 per cent in June, again significantly below the 8.3 per cent recorded in May. This was also significantly due to softening food prices, with food inflation at 7.9 per cent and vegetables, which have been recording double-digit rates for a long time, finally coming in at 8.7 per cent. The headline numbers, particularly on the CPI, may raise hopes that the Reserve Bank of India can finally begin to lower interest rates. But, for a number of reasons, those expectations may be premature.

First, the spike in onion prices earlier this month will very likely cause CPI inflation to turn up again in July. For whatever reason, core CPI inflation is itself apparently closely tracking food prices; so, as it turns up, any room that the RBI has to rationalise a rate cut will diminish. In any case, the RBI framework now uses the headline number as a benchmark and will, therefore, take into account the risks of an upturn. But it is not just an onion problem. It is now the third week of July, and there is a question mark over the revival of the monsoon, which so far has remained poor in large parts of the country. The sowing of several crops will be significantly less than normal; and, thus, the overall production of many rain-dependent crops will be low. Price pressures are inevitable. While the RBI should not see this as a reason to increase rates, it will almost certainly feel constrained to maintain the status quo. In short, whatever relief may be obtained from the June inflation numbers is almost certain to be rather short-lived.

This situation highlights just how severe a bind macroeconomic conditions are in currently. The change of government was expected to provoke animal spirits, which would then spark an investment revival. And, by means of the Budget and other initiatives, some effort is clearly being made to do this. But, whatever else may happen, investment activity is unlikely to pick up significantly if interest rates remain at these levels. Many projects will simply be unviable in these circumstances, however attractive they may appear to be on paper. In other words, bringing inflation down sharply is not just a political imperative; it is essential to create the minimum conditions necessary for growth to revive. The Budget gave a fair amount of emphasis to agriculture, but was sparing in details. Now, the agriculture, food and other related ministries must quickly articulate their strategies to deal with both the short-term threats and the long-term constraints that are keeping food inflation elevated.