RBI is barking up the wrong inflationary tree

Woof, woof! RBI is barking up the wrong inflationary tree

Manika Premsingh Jun 17, 2011

While raising interest rates by 25 basis points on Thursday, the RBI pointed to “demand-side pressures” or ‘core inflation’ as a crucial factor that would determine future monetary policy moves.

Core inflation pressures — that is, inflation measures that exclude items that face short-term volatile price movement, such as food and energy — are indeed on the rise. But inflation driven by “supply-side” considerations is still stronger, and that cannot always be effectively curtailed through monetary policy action. In fact, there’s the risk of over-reliance on monetary policy to tackle overall inflation.

In raising the repo rate to 7.5%, the RBI said that it “will contain inflation and anchor inflationary expectations by reining in demand-side pressures.” The Finance Ministry too issued a press release in support of the RBI’s move, and in fact went a step further, and shared figures for “core inflation”.

Core inflation is a measure of genuine demand-side price pressures (where “too much money chases too few goods”). Supply-side inflation is determined rather more by lesser availability of, for instance, food crops because of a drought; or lower supply of crude oil due to geopolitical tensions in the Middle East.

The ministry estimates that core inflation rose to 8.7% in May 2011, up from 7.9% in April.

Core inflation has indeed been on the rise since the start of 2011, and hit a high of 9.2% in March 2011 — the highest since September 2008. But it is important to note that the figure has been consistently below actual wholesale price index (WPI) inflation.

In other words, while core inflation has played its part, overall inflation has been driven rather more by supply-side factors. Over the past 12 months, food, crude and ‘fuel and power’ inflation has risen on an average by 13.7%, 8.4% and 12.1% as compared with a 9.3% increase in overall inflation. With a hike in diesel prices on the anvil, such supply-side pressures will only increase.

Core inflation data are not released formally, but most economists have their own estimates based on price components other than food and fuel, which might show minor variations but will likely have the same broad trend.

Interestingly enough, the RBI never once mentions the term in its own policy document, though it does make a reference in the end to ‘demand-side pressures’ on the economy.

Source: http://www.firstpost.com/business/rbi-barking-up-wrong-tree-27285.html?utm_source=MC_HOME


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