Inflation conundrum (The Hindu)

Mains Paper 1: Economy
Prelims level: CPI
Mains level: Economic growth and development, different indexes and their impacts

Context

•  The multi-month low retail and wholesale inflation prints for December pose an interesting challenge for policymakers and the central bank.
•  Inflation in Consumer Price Index (CPI), at 2.19% in December, is at an 18-month low, while the WPI, at 3.8%, is at an eight-month low.

Policy maintained by the RBI

•  The Reserve Bank appears to have been blindsided by the CPI number, which is way below projections made during its last few monetary policy pronouncements.
•  The RBI has maintained a CPI projection of 4.4-4.8% for the second half of fiscal 2019.
•  The bank projected 3.8-4.5% retail inflation in the second half with upside risk, and even changed its policy stance to “calibrated tightening” from “neutral”.
•  The MPC and the RBI may well want to reassess the robustness of their inflation projection mechanism in light of the data coming in.
•  When the new Governor, Shaktikanta Das, sits down with the monetary policy committee (MPC) in early February he may well have to return to a “neutral” stance given the soft trends in headline CPI.
•  There may even be pressure on him to look at a rate cut, especially given the weak economic data coming in factory output growth was a low 0.5% in November with manufacturing showing a contraction.
•  The automobile industry, the first to feel the effect of an economic slowdown, has seen sales falling over the last two months.

What inflation data says?

•  The inflation data have also thrown a curveball at policymakers in that their different components show divergent trends.
•  So, while headline CPI inflation is trending lower, core inflation is still sticky at close to 6%. Again, there is a divergence between core rural and urban inflation the former is trending higher at 6.34% while the latter is heading downward at 5.26% in December.
•  Curiously, rural health and education index numbers are high.
•  The point with all this divergence in data is that monetary policymaking is a challenge.
•  Governor Das alluded to this in a recent speech where he pointed to the divergences and volatility in different sub-groups as a major challenge in inflation assessment and projection. But

Way forward

•  The broader question is whether the interest rate structure is lagging behind the big structural change in inflation in the last few years.
•  According to Mr. Das, headline CPI inflation has moderated from around 10% in 2012-13 to 3.6% in 2017-18 and 3.7% in April-December this fiscal.
•  The nominal interest rate structure has not changed significantly, leading to rather high real interest rates. Prominent policymakers, including principal economic adviser Sanjeev Sanyal, have called for the RBI to take a re-look at the interest rate structure.
•  It will be interesting to watch how the RBI under the new Governor reacts to these calls.

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General Studies Pre. Cum Mains Study Materials

Prelims Questions:

Q.1) With reference to Monetary Policy Committee (MPC), consider the following statements
1. RBI Act was amended to constitute MPC
2. The members of MPC will meet quarterly
3. Both government and RBI decide the monetary policy of India
4. MPC was set up based on the recommendation of Urjit Patel Committee

Select the correct answer using the code given below.
a) 2 and 4 only
b) 1, 3 and 4
c) 2, 3 and 4
d) 1, 2, 3 and 4

Answer: D

Mains Questions:
Q.1) A weak performance and low inflation may persuade the RBI to go for an interest rate cut. Explain it.