INFLATION: Global food prices to set trend

OUTLOOK 2008

Headline inflation in India (inflation measured in terms of the Wholesale Price Index) in 2008 will depend much on how food prices behave globally and how much of the increase in oil prices will be passed on to the consumers.

Goldman Sachs predicts WPI inflation to be 4.4 per cent in 2008, whereas chief economist of Axis Bank, Saugata Bhattacharya, believes inflation will fall to 4 per cent only in the worst-case scenario. Arun Kaul, GM (Treasury), Punjab National Bank, believes inflation may rise to 5 per cent by March 2008.

WPI inflation rate, after remaining above 6 per cent level during January-April 2007, declined below 4 per cent after 68 weeks due to supply-side improvements in some essential commodities and monetary and fiscal measures taken by the Reserve Bank of India (RBI) and the government.

However, after declining to 3.2 per cent by November 17, 2007, it has again started rising, largely due to a lowering of base effect, raising concerns of higher prices in 2008.

The major factors that caused the rise in inflation rate are increasing food prices. Stiffening of inflation started with shortfalls in domestic supply of some agricultural commodities, mainly wheat, pulses and edible oils, and were supported by hardened international prices of some essential commodities. However, the situation is expected to improve next year.

Sugar, which has a weight of 3.62 per cent in the WPI basket, saw prices crashing by almost 25-30 per cent in 2007 on bumper production and stable demand. With the forecast of another record output in the ongoing sugar season (October-September), price will remain under downward pressure.

Price of wheat, which has a weight of 1.38 per cent in the WPI basket, is expected to remain stable during next year on bumper production.

Rice, with a weight of 2.45 per cent in the WPI, has seen price rise of about 10 per cent this year, on stagnating output and area diversion to high-end varieties for exports. Rice traders see acreage and output on a higher side next year since farmers got a better price this year. This is expected to keep prices under check.

However, in spite of good harvests, India can hardly escape the impact of hardening of global food prices. Analysts feel many factors like global climate change and shift in agricultural practices towards high-yielding crops to be causing high food prices. These factors are expected to only aggravate next year.

Though international crude oil is trading over $90 per barrel, the government has desisted from increasing the domestic retail prices of petrol and diesel since February 2007.

Though an oil price hike seems imminent due to growing losses of oil marketing companies, the government may only be able to pass on a small part of the high crude prices with general elections looming large.

But according to Goldman Sachs estimates, even if domestically fuel prices are raised by 10 per cent, it would increase inflation by 0.6 percentage points over a 12-month period.

Another reason that has kept the government on its toes throughout this year is huge capital inflows increasing domestic liquidity and thus causing inflationary pressure.

The RBI has repeatedly increased lending rates and taken measures to suck out surplus cash from the financial system after a spike in inflation earlier this year triggered fears that the economy might be overheating.

The government in its Mid-Year Review of the economy has also cautioned that monetary management will be key to reign in inflationary expectations next year.

However, the capital inflows causing the rupee to appreciate has also helped to make imports cheaper, thus contributing to keep inflation under check. Goldman Sachs also estimates that 1 per cent appreciation in the rupee will reduce headline inflation by 0.15 percentage points.

The world commodity prices which have been hardening for the last three years "" mostly due to higher demand from China to build its infrastructure for the 2008 Beijing Olympics Games "" is expected to soften next year.

The International Monetary Fund, in its World Economic Outlook, October 2007, has indicated a moderation in the inflation for metals and near stability for other commodity prices. This may further help in containing inflationary pressures.