Column: Honey, it’s not just onions!

Oct 18 2013, 04:07 IST
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SummaryAttributing the pick-up in inflation momentum largely to onion prices is a misreading of the data

Here’s the good news. A semblance of macroeconomic stability is finally returning to India. The rupee has mean-reverted smartly. The CAD is on course to print well below the government’s $70 billion target. And the government is expected to find a way—or make one—to keep to its budgeted fiscal deficit.

These are clearly welcome developments. But just as excessive pessimism was unwarranted mid-year, excessive optimism should be avoided in the Fall. Part of the reason the rupee has strengthened is because there is no oil demand in the market. So, for all intents and purposes, India’s spot FX market is currently like a current account surplus country. And that cannot go on forever. Furthermore, apart from gold, the narrowing of the CAD is largely cyclical—with the growth gap between India and the rest of the world narrowing. That said, the 11% real depreciation of the currency since May should undoubtedly provide some competitive advantage to India’s exports. Finally, the fiscal consolidation is welcome but the means (draconian expenditure compression at the end of each year) appear unsustainable and will pull down growth in the coming quarters. Instead, at some point, we need true fiscal reform—a GST, extending UID and cash transfers to all subsidies. Similarly, the structural drags underpinning the CAD—coal, scrap metal and fertiliser imports, iron ore exports, FDI profit repatriation—still need to be addressed. Therefore, recent improvements can be thought of as being on a course of paracetamol to tame the symptoms, and buying time to embark on a needed course of antibiotics.

In contrast to some normalcy on these twin deficit issues, there have been a set of jarring inflation prints. WPI inflation is back up in the 6% handle. And CPI inflation continues to hug the double-digit mark with core CPI rising to 8.4%! But even the uncomfortably high year-on-year prints understate the underlying inflation momentum. This is the fourth consecutive month that headline WPI has increased more than 1% month-on-month (seasonally-adjusted). On a quarterly, annualised basis therefore, WPI inflation is actually running in double digits! Ditto for the CPI.

Yet, the morning after, market and press analysis have focused almost exclusively on the role of onions, in driving the recent inflation uptick! Why is this important? Because if you believe inflation pressures are mainly reflecting a temporary supply-shock, policymakers should be expected to see through that. These shocks, by virtue of being a one-off, should affect the price

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