The debate has already started again on the inflation-growth trade-off and whether the RBI should let go of its strong anti-inflationary stance and stop hiking policy rates. Dr Y.V. Reddy, former governor of RBI, in an interview, sounded a cautious note on raising policy rates further, as the transmission of raised policy rates is still working through.

There is strong resistance from India Inc, which fears that any further hike will hurt investment and growth. Any explicit statement from government sources is yet to come, but it is most likely that hints for not raising rates will soon start coming in, in anticipation of the forthcoming policy review on July 28.

Dr Duvvuri Subbarao, while inaugurating Statistics Day on Tuesday, communicated in a transparent manner that, given the limited efficacy of monetary policy in dealing with food and fuel inflation, and the limits on using core CPI inflation measures, the RBI has focused its attention on non-food manufactured products inflation as an indicator of demand-side pressures in the economy. Generally, core inflation is a derived inflation measure from headline inflation.

He added that while it is true that commodity prices influence the non-food manufactured products component of WPI, it is also true that the pass-through from higher commodity prices to WPI depends critically on the underlying demand conditions in the economy. Taking a cue from this, this article tries to break up the core and non-core components of WPI inflation in the recent period and take a view on the policy stance.

Trends in WPI Inflation

The period since April 2005 can be split into about five phases. Till October 2007, preceding the global financial crisis, the inflation rate was range-bound, beginning with 5.3 per cent and ending with 3.2 per cent with an average of 5.3 per cent. From November 2007 onwards, we see highly volatile rising and falling phases till April 2010. The inflation rate rose from 3.7 per cent in November 2007 to 11.1 per cent in August 2008 with an average of 7.5 per cent.

The rate fell steeply from 10.8 per cent in September 2008 to a negative 0.3 per cent in July 2009 with an average rate of 4.5 per cent. Again, inflation rate rose steeply from 0.5 per cent to 10.5 per cent between August 2009 to April 2010. This is the period when inflation was considered more a result of the rise in food prices and views were pouring in, particularly from government circles, that it would not warrant tight monetary policy action. In the last year or so since May 2010, inflation has persisted at a stable but very high level.

Despite predictions from time to time that the inflation rate would fall to comfortable levels even before March 2011, no easing of inflation is evident. The rate fell marginally from 10.5 per cent in May 2010 to 9.1 per cent in May 2011 with an average rate of 9.4 per cent. By any standard, the rate has not reached its comfort zone at all and the median forecast for this fiscal year end has been hovering in the 7-8 per cent range, much above the government's and the RBI's projections.

Core, Non-core Components

There are two non-core components, namely the food index and fuel and industrial inputs index.

The trends in these components, along with core inflation and overall inflation, are depicted in the Graphs A and A1. It is evident that core inflation started rising steeply beginning January 2010, and nearly converged with the overall inflation rate. Two things are happening currently.

The rise in the food index from 13 per cent in August 2009 to 16.1 per cent in April 2010, with a weighted contribution of 147 per cent, impacted the overall inflation through core inflation with a lag. The weighted contribution of core inflation, which was in the negative zone of 18.7 per cent, has become positive at about 37 per cent in the last year or so. This has worked through wage pressures and general demand pressures, making the current inflation a generalised phenomenon. Hence, its taming is of utmost urgency at this point in time.

No doubt, unlike food inflation, which impacted core inflation with a lag, that in in industrial inputs and fuel impact the inflation rate almost contemporaneously. Growth in the industrial inputs index was in the 15-32 per cent range since January 2010. The good news is that, of late, it has been declining, and this should have a positive impact on inflation in the months to come.

The fuel index also has been somewhat stable at around 12 per cent in the recent past. But, given the lagged pass-through from administered pricing, the hikes in fuel prices will add to pressures on inflation in the coming months. Tax sops for these products, excepting in the case of kerosene, are better avoided to contain demand pressures for these products and also in the interest of sustaining government revenues.

Overall, the comfort zone on the inflation front will not be reached any time soon. A truant monsoon can spoil any potential benefit from a fall in food inflation. The comforting factor is that the growth engine is at full throttle and this year is not going to see any rate below 8.5 per cent. Therefore, in public interest, if we take care of inflation, growth will take care of itself. On no account is this the time for softening the strong anti-inflationary monetary policy stance.

(The author is Director, EPW Research Foundation. The views are personal. >blfeedback@thehindu.co.in )

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