The latest headline inflation data should queer the pitch for the Reserve Bank of India (RBI) as it makes up its mind on the end-quarter monetary policy action this week. The wholesale price index (WPI) has been reported to have risen by 9.06 per cent in May 2011 over May 2010, up from the 8.66 per cent jump in April over April last year. Given observed data and continuing expectations, it remains to be seen whether the RBI will prefer a 25 basis point (bp) increase in its policy statement this week, or would want to administer one more shock, as it did six weeks ago, and opt for a 50 bp hike. Most expect a milder dose of 25 bps this Thursday. The higher-than-expected rate of inflation is in large part on account of a sharper increase in the price index for manufactured products, where the inflation rate has gone up from 6.18 per cent in April over April to 7.27 per cent in May over May. It suggests that the reported slowing down of industrial growth has not weakened pricing power in manufacturing. It is a moot point if this shows continued overheating of the industrial economy, but it certainly suggests that monetary policy must continue to be deployed to manage inflationary expectations.
There is, however, a caveat that must be entered. Apart from the long- stated concern about using WPI rather than the consumer price index as an indicator of inflationary expectations (justified on the grounds that WPI is a better indicator of producer prices) the fact remains that India’s economic data still suffers from a time lag in publication. Far too many macroeconomic policy decisions, statements and judgement calls are being made on the basis of weak and dated data. Macroeconomic authorities in developed economies have access to more recent and accurate production and price data and are, therefore, able to fine-tune policy to changing sentiment and outcome. Given time lags and coverage shortcomings, it is not clear whether Indian macroeconomic authorities should be responding so frequently to price and output trends and adjusting policy rates every six weeks. The RBI has raised rates ten times between March 2010 and June 2011. Yet, the central bank has not broken the back of inflationary expectations. It is not clear if just five policy interventions, based on a better understanding of trends, would have been less effective. Frequent and incessant comment on weak and unreliable data does not amount to sound policy. Instead, a measured but decisive intervention in sync with observed and expected trends may serve policy objectives better.
Going forward, given the imperative to increase diesel and other fuel and energy prices, inflation management would require greater effort on the fiscal front, liberalisation of internal trade policy and easing of other supply bottlenecks. Monetary policy alone cannot win the battle against inflation.