Not only imported inflation, but even domestic core inflation has been driven by exogenous factors such as gyrations in global commodity prices, especially in oil
In the first part of this piece (FE, January 23), we had explained how the domestic monetary policy conduct is being increasingly influenced by external factors, as the Indian economy is being closely interlinked with its global counterpart. We believe that this integration may be increasingly diluting the effectiveness of domestic monetary policy actions to contain inflation. In this concluding part, we analyse this hypothesis.
Let us first start with the movements in core inflation in April 1995-December 2012 (the latest month for which data has been released). For April 1995-March 2004 (with 1993-94 as the base), the weight of core inflation/non food manufacturing was 52.2% and that of imported core was roughly 40.7%. After the weights were revised in 2004-05, and the new WPI index launched, the share of imported items were roughly 48.9%, while that of core items at 54.9% (share of imported core stood at 33%, up from 29% and that of non-imported core declined). Interestingly, while there is no unanimity or official estimate of the share of imported items in WPI, we followed the decomposition that RBI had given out in its October 2011 monetary policy announcement (for both the 1993-94 and 2004-05 WPI series).
As Graph 1 shows, core inflation that was ruling high at more than 12% in April 1995, turned negative in January 1997, on the back of a significant decline in imported inflation and a de-growth in domestic core inflation (June 1996-May 1997). The trends in core inflation suggest that it touched a peak in January 2001, July 2004, August 2008 and November 2011. However, more importantly, in the run-up to all such cases, the contribution of imported core was becoming more significant, driven by a flare-up in oil prices, or rupee exchange rate. The movements in inflation were becoming more influenced by external factors, on which RBI had little control.
Apart from the trends in imported core, the trends in domestic core deserve a special mention. Domestic core prices were getting increasingly aligned with the international trends in commodity prices (see Graph 2) with the passage of time, reflecting a progressive pass-through of input costs.
For example, over the entire period (April 1995-December 2012), the correlation coefficient between the Reuters CRB Index and the non-imported core was negligible,