Disinflation dividends

Moderating food prices help reduce inflation

The August numbers for both the Consumer Price Index and the Wholesale Price Index were published on Monday. The rate of consumer inflation came in at 3.66 per cent, lower than the previous month's 3.69 per cent and, very significantly, driven by an extremely reassuring rate of food inflation of 2.2 per cent, about the same level as the previous month's. These two readings suggest that, as erratic as the monsoon may have been in the second half of the season, its early abundance seems to have contributed towards controlling food prices. Most importantly, this low rate has manifested notwithstanding significant increases in the prices of onions (over 65 per cent year-on-year in wholesale markets) and pulses (almost 26 per cent year-on-year at the retail level). Onion prices appear to have been offset by declining prices of other vegetables, with the overall index for this category having risen by 2.2 per cent in the CPI. Other than pulses, the prices of other protein sources also increased relatively slowly, while the prices of sugar and related products declined by over 13 per cent. Despite the monsoon having taken a turn for the worse in August, it is now food prices that are helping to take headline inflation down, in contrast to the past several years.

On the wholesale front, the streak of negative numbers continued, with the index declining year-on-year by 4.95 per cent, the largest decline since April. Food prices fell by 1.13 per cent, accompanied by a continuing decline in energy and commodity prices. The fuel and power index was down by over 16 per cent year-on-year, while minerals were down by almost 30 per cent. While many observers are pointing to the overall trend as a sign of deflation, the more appropriate explanation for the behaviour of the WPI is disinflation, i.e., a sharp fall in the prices of commodities with high weights leading to a negative year-on-year change. Since the price of crude oil fell sharply in September of 2014, this will very likely be the last monthly reading with a large negative rate. The inflation rates over the next few months should provide greater clarity on what the momentum in this index really is. Odds are that the number will turn out to be very low, but not quite in the same negative zone as in the first five months of the current year.

Since the Reserve Bank of India now focuses on the CPI, that number will be the key determinant of the policy decision scheduled to be announced on September 29. The CPI inflation rate has been consistently belying the risk assessments made by the RBI over the past few months. Had the current trajectory been forecast during that period, chances are that the repo rate would have been somewhat lower than it currently is. The latest reading should provide a strong enough rationale for a rate cut. It also raises some fundamental questions about the state of the food economy and the impact of the monsoon on agricultural production and prices. Will this year be seen as marking the start of a new trend or merely an aberration?