In his recent monetary policy review statement, the RBI Governor, Dr D. Subbarao, has projected that the wholesale inflation rate will “begin falling in December 2011 and then continue down a steady path to 7 per cent by March 2012”. What explains this optimism, reflected in the reference to reassuring “momentum indicators”?

A look at the ‘WPI-All Commodities Index' indicates that the assertions could be based, to a large measure, on a favourable base effect coming into play in December, which should help achieve what a sustained rate hike spree since early last year has failed to accomplish.

The base effect essentially refers to the statistical impact of the previous year's high index reading in calculating the annual inflation. Data show that the ‘WPI-All Commodities Index' reading for December 2010 had shot up to 146 points from November's 143.8 points — a 1.5 per cent sequential increase compared with an average sequential increase of 0.6 per cent in the previous two months.

As a result, the year-on-year headline inflation estimate for this December, which will use the All Commodities Index reading for December 2010 as the base, should see sharp moderation as the base year reading is high. Going forward too, the index shows big spurts in both March and April 2011. This should sufficiently ensure that by the beginning of next fiscal (March-April 2012), the headline inflation estimate would dip further, exactly in line with the RBI's projections, with the base effect again coming into play.

In its efforts to bring runaway inflation under control, the RBI has raised the benchmark rate by 375 basis points since March last year. Despite these measures, headline inflation was recorded at 9.72 per cent in September, its tenth straight month above 9 per cent and the highest among the BRIC group that includes Brazil, Russia and China.

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