Pesky prices

The inflation rate, as measured by the Wholesale Price Index (WPI), has hovered in the 5-5.5 per cent range for the past several weeks. As this is the range which the Reserve Bank of India (RBI) has indicated as its outlook for the year, things should seem pretty much under control. However, last Friday's weekly announcement placed the figure for the week ending November 18 at 5.45 per cent, dangerously close to the upper bound and about 1.3 percentage points higher than the level at the start of the financial year. And since these provisional numbers have usually been revised upwards, wholesale prices may already be out of the RBI's preferred band. Consumer price inflation has been even higher in recent months, at about 6.5 per cent. This inevitably heightens concerns about the growth-inflation spiral and potential policy responses to it, which may pose a threat to the current growth momentum. But, it is perhaps premature to reach any dire conclusions about the links between the 9.2 per cent GDP growth during the second quarter (July-September) and accelerating inflation. The 5-5.5 range may still be attainable.

That is because, while the first half of 2006-07 has clocked over 9 per cent GDP growth, there is a reasonable probability that growth during the second half will be somewhat slower. The cumulative impact of successive increases in interest rates and a moderating US economy are two important factors contributing to this assessment. Of course, there are no indications as of now as to third-quarter performance. The first one will come next week, in the form of the October Index of Industrial Production numbers. It would be prudent to wait until there are some signs of second-half performance, however preliminary, before concluding that the recent upward trend in inflation will continue.

Beyond this, it is important to consider the sources of increase in the WPI. In response to last week's numbers, the finance minister stated that this was primarily a supply-side boost to the index, caused by higher prices for pulses and some minerals. This argument underlines a basic problem with using an index such as the WPI to measure inflation. It does not distinguish between an increase caused by a large hike in the prices of a small number of commodities, as has happened on a number of occasions in recent months, and a widespread increase over most commodities (i.e. generalised inflation). It is up to analysts to decipher which one is the predominant cause of changes in the index. As it happens, there is a bit of both going on, which is at the heart of the differences of opinion occasionally expressed by the finance ministry and the RBI. This time, however, both seem to be on the same wavelength, as reflected by Deputy Governor Rakesh Mohan's statement about declining prices of petroleum products.

This does not in and of itself provide any indication that the RBI will not persist with its anti-inflationary stance. October's rate hike is quite likely to be followed by another one in January, based on the second-quarter growth numbers. By the end of January, third-quarter performance, based on industrial production numbers and corporate results, can be accurately gauged. Unless there is a sharp drop-off, a mild application of the brakes is the prudent thing to do.