How India has kept its CPI & WPI inflation under control

Has India finally tamed the inflation demon?

The CPI and WPI numbers that came in during the week were a whiff of fresh air. CPI inflation at 4.20% is now already well below the RBI comfort level of 5%. The WPI inflation at 3.30% is also showing signs of tapering. There are broadly 4 issues to understand…

Food inflation is down…

The one reason why lower CPI inflation may be sustainable is because food inflation is sharply down to 3.23%. That is partially an outcome of a better monsoon and partly on expectations of a better Kharif crop. Also, the government has managed to address some critical supply side bottlenecks. As pulses, cereals, vegetables and fruits moderate, it looks like food inflation will not be the main concern even after the base effect starts waning

 

OROP / 7CPC well absorbed…

The big worry in this year was that the impact of OROP and 7CPC payouts may be inflationary. The last few months have not betrayed any signals. It is apparent that the liquidity has been substantially absorbed and there is really no consumption rush that may spur inflation higher from current levels. In the last monetary policy, there were concerns expressed over the upside risks to inflation due to liquidity infusion. That point seems to be largely taken care of. Hence, low CPI inflation could be actually sustainable.

 

Oil Prices could stay weak…

The one big risk to inflation in India was the return of high oil prices. For now, that appears to be unlikely. With an output agreement highly unlikely, crude prices may be headed below $40/bbl. That will mean that the oversupply problem is not going to be addressed in a hurry. Additionally, the global oil stockpiles to the tune of 3.2 billion barrels as well as the world running out of storage space may imply that oil prices may be headed further down. Thus WPI and CPI do not face any immediate upside risks from higher oil prices, at least till mid-2017.

 

The Liquidity Squeeze…

The one factor that may actually aid lower inflation will be the liquidity squeeze in the economy. The effort to demonetize notes of higher denomination has created a huge demand/supply imbalance in the Indian market. As liquidity stays weak for the next 3-4 months till the replenishments come in, the demand scenario in India is likely to remain weak. Weak demand virtually obviates the possibility of demand-pull inflation and to that extent will have a salutary effect on CPI and WPI inflation. On the downside, one only hopes that the liquidity squeeze does not hit growth and jobs in the SME sector. If that happens, it may be an exorbitant price to pay for low inflation; surely not worthwhile!

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