Now that September CPI has risen to 9.84% from 9.52% for August, inflation hawks have started arguing RBI is likely to raise policy rates in its next policy. That would be a mistake for a variety of reasons. For one, with both IIP and PMIs falling, it is difficult to see how inflation, either CPI or WPI, can be rising. While the RBI’s definition of core WPI is up from 1.9% in August to 2.1% in September, in the light of the rupee’s collapse, this suggests near-zero pricing power with manufacturers—as compared to a year ago, core WPI is down from 5.2%, suggesting the need to cut repo rates. But CPI, inflation hawks argue, is up and that alone matters for inflationary expectations. Is it?
For one, as we have pointed out before, there are problems with CPI with various sub-components of it, even rural and urban rates, converging though they have vastly different weights. Two, how do you explain services CPI inflation rising or remaining flat when services growth has been slowing based on GDP data, and contracting at an increasing rate over the past 3 months based on PMI data? Part of the answer lies in soaring vegetable prices, rising from 5.8% in April to 34.9% in September—with a weight of 5.4% in the index, this means CPI-sans-veggies was 7.94% in September, down from 8.12% in August, 8.74% in July … The larger problem is that since neither food (49.7% weight in the overall CPI index) nor fuel (9.5%) respond to monetary policy, it makes little sense to use CPI as a guide to policy. Governor Raghuram Rajan may as well use the monsoon indicator, raise rates when it fails, lower rates when it is bountiful. Or vice versa.