India’s inflation fight: a temporary victory
New figures show Indian inflation at a two-year low, but analysts warn that the structural drivers of price growth remain intact
Could Indian policymakers finally be winning the battle against the countrys stubbornly high inflation rate?
Despite hiking interest rates 13 times between March 2010 and December 2011, Indias benchmark wholesale price index (WPI) had continued to track above 9% throughout the second half of 2011, despite signs of moderating price growth across other fast-growing emerging economies.
But the latest inflation numbers released on January 16 showed that year-on-year WPI growth slowed to 7.47% in December, from 9.11% in November. Food price inflation slowed particularly sharply last month, with the food component of WPI rising by just 0.74% on an annualised basis in December, compared to 8.54% y-o-y growth in November.
While this still represents significantly faster inflation growth than its BRIC peers, a 7.47% inflation rate is seen as cause for cheer in India these days, enough to give the doves some firepower to argue for rate cuts to kickstart the countrys flagging growth.
Most analysts expect Indian inflation to continue to moderate in the coming months. Capital Economics expects WPI inflation to remain on a downward trajectory throughout 2012, averaging around 6% y-o-y growth. The London-based consultancy expects the RBI to take advantage of this increased policy space by cutting interest rates to 7.0% by the end of the year, from 8.5% at present.
The December inflation numbers have also provided a timely boost to Indias beleaguered currency and stock markets. The rupee strengthened by 0.3% against the dollar to 51.3950 on Monday, while the BSE Sensex edged up 0.22% on the back of the release of the inflation numbers. The Sensex was the worst-performer among major emerging market equity indices in 2011, while the rupee has hit a series of all-time lows against the dollar in recent months.
However, before policymakers get too carried away, they would do well to bear in mind the findings of a detailed study of the drivers behind Indias stubbornly high inflation rate by Nomura analysts Tomo Kinoshita and Aman Mohunta, also published on Monday.
The report suggests that while WPI inflation is likely to moderate in the short-term, that the structural drivers of high inflation in India demand-side drivers, food price pressures and capital stock deficiency remain intact.
In particular, Kinoshita and Mohunt warn that measures aimed at boosting rural incomes and alleviating poverty such as the National Rural Employment Guarantee Act and food subsidies, will continue to raise rural incomes as well as widen the fiscal deficit, creating inflationary impact. Furthermore, rising protein consumption will place additional upward pressure on food prices, especially if rains continue to fail. Finally, the analysts cite the countrys low capital stock-to-GDP ratio as creating bottleneck inflation pressures whenever growth accelerates, adding that supply-side shortfalls will persist unless there is a marked acceleration in infrastructure investment.
The above analysis shows that Indias inflation is likely to moderate in the short term, but strong inflationary pressures are likely to continue to put upward pressure on inflation in the medium term, the report concludes.
In other words: keep the champagne very much on ice.
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