Rajeev Malik: Flying in the dark

All the players concerned are practically in the dark when it comes to an objective quantitative assessment of the current inflation rate and its outlook.

The WPI inflation has breached the 5 per cent mark for the first time in nearly a year. Indications are that inflationary pressure is likely to increase owing to a combination of booming domestic demand, rising food prices, and more complete pass-through of the recent hikes in petrol and diesel prices.

What complicates matters for the government, the RBI, and financial markets is that no one appears to have a good handle on the pace of increase in prices, owing largely to the shortcomings of the official WPI, and a severe drought of other high-frequency data, such as those covering the labour market, which could have offered some clues about the changing drivers of demand.

To be sure, the measurement issues with the WPI are not new, but the government's response in fixing them has been frustratingly slow. In the absence of a reliable indicator on inflation, a key reason for investors' worry with India's inflation outlook is that it is almost a free-for-all in guessing what the magnitude of the different underlying drivers of inflation are, and the pace at which these are likely to change. Concluding that inflation is likely to rise is not enough; indeed, there have been no acceptable available details that monitor the evolving price situation, and aid in deciding whether a central bank is ahead or behind.

Most likely, demand-driven inflationary pressures will become more palpable, though food inflation could soften owing to a combination of recent fiscal measures and a decent monsoon. Increased competition has slowed the pace of price increases in manufactured goods, but the central bank's comfort level of inflation has also declined. Further, anecdotal evidence suggests high turnover in private sector jobs, and continuing strong gains in income, which will only add to higher inflation. Interest rate changes do little to rein in food inflation, though the rate hikes can reassure the financial markets about a central bank's commitment to its hawkish stance. Policy changes that affect supply and distribution of food items are much more effective in checking rising food prices, but here the government's recent response has been slow.

Despite the crucial information gaps on inflation, the RBI has been quite accurate in its reading of the evolving inflation landscape. It is reasonable to expect the RBI to use a combination of hikes in interest rates and the cash reserve ratio (currently at 5 per cent) in the next six months to keep inflation and torrid credit expansion in check. Hopefully, now the RBI's assessment and credibility will not be undermined by widely reported disagreements to the government to rate hikes.

Rajeev Malik is vice-president and senior economist with JPMorgan Chase Bank, Singapore. The views expressed here are personal