Headline inflation moderated from over 8 per cent in September 2012 to 7.2 per cent in
December 2012. The significant slowdown in growth below trend led to a decline in non-food
manufactured products inflation. Food inflation, however, continued to persist at elevated levels
as new drivers emerged, which was also reflected in double-digit consumer price inflation.
Inflation is expected to moderate gradually, supported by softer global commodity prices and
weak domestic demand even though some pressure could be felt from the staggered increases
in diesel prices. Also, there are continued risks from persistent price pressures from food,
high inflation expectations and wage-price spiral, leading to further pressure on generalised
inflation.
Global inflation conditions remain benign,
albeit with some pressure in EMDEs
VI.1 Subdued global inflation environment
in AEs continued into Q3 of 2012-13, as
weaker global growth dampened demand
conditions and commodity prices remained
range bound. The average inflation in OECD
countries was 1.9 per cent in November 2012,
with core inflation (excluding food and fuel)
being lower at 1.6 per cent. Among the major
EMDEs, China recorded inflation of 2.5 per
cent in December 2012, while inflation in
Russia, Brazil and South Africa ruled above 5
per cent.
Fresh round of quantitative easing (QE)
enhances global liquidity
VI.2 Continued weakness in the global
economy has forced the central banks in most
AEs to continue with extremely easy monetary
policy of near zero nominal interest rates and
quantitative easing (Table VI.1).
VI.3 The US Federal Reserve (US Fed)
expanded its QE from the start of 2013 with
the expiry of Operation Twist. The Bank of
Japan expanded the size of its QE further and in
January 2013 adopted a revised inflation target
of 2 per cent. The US Fed also tweaked its
September 2012 forward guidance of keeping
the target range for the federal funds rate at exceptionally low levels of 0 to 0.25 per cent
until at least mid-2015 with an indication to
do so till: (i) the unemployment rate remained
above 6.5 percent, (ii) inflation between 1–2
years ahead was projected at no more than
a 0.5 percentage point above its 2 per cent
longer-run goal, and (iii) longer-term inflation
expectations continued to be well-anchored.
However, in January 2013 it indicated the
possible end of QE before the end of the year
on concerns over the sustainability of such
large-scale asset purchases in view of risks
associated with financial stability and the size
of its balance sheet.
VI.4 As the recovery prospects for the
global economy remain weak (see Chapter
1) amidst high unemployment, spare capacity
and subdued wage pressures, the monetary
policy stance of AEs is likely to continue to
remain accommodative. Following significant
slowdown in growth in the recent period,
more and more central banks in EMDEs have
reduced their policy rates to address growth
concerns.
Muted global growth indicates range-bound
global commodity prices in the
near term
VI.5 International commodity prices
gradually moderated during Q3 of 2012-13
after exhibiting some uptick in Q2 (Chart VI.1).
Crude oil prices moderated as supply prospects
improved and geo-political tensions eased in
the Middle East. Moreover, the prospects of a
weaker global economy also played a role in
keeping oil prices range-bound. Metal prices
continued to show signs of weakening as
demand has slowed significantly, especially
from China.
Table VI.1: Global Inflation Indicators |
Country/ Region |
Key Policy Rate |
Policy Rate (as on January 24, 2013) |
Changes in Policy Rates (basis points) |
CPI Inflation (Y-o-y, per cent) |
Sep 2009 to Dec 2011 |
Jan 2012 to Jan 2013 (as on 24th Jan) |
Dec-11 |
Dec-12 |
1 |
2 |
3 |
4 |
5 |
6 |
7 |
Advanced Economies |
|
|
|
|
|
Australia |
Cash Rate |
3.00 (Dec 5, 2012) |
125 |
(-) 125 |
3.0# |
2.2# |
Canada |
Overnight Rate |
1.00 (Sep 8, 2010) |
75 |
0 |
2.9$ |
0.8$ |
Euro area |
Interest Rate on Main Refinancing Operations |
0.75 (Jul 11, 2012) |
0 |
(-) 25 |
2.7 |
2.2 |
Israel |
Key Rate |
1.75 (Jan 1, 2013) |
225 |
(-) 100 |
2.2 |
1.6 |
Japan |
Uncollateralised Overnight Call Rate |
0.0 to 0.10* (Oct. 5, 2010) |
(-) 10 |
0 |
-0.5$ |
-0.2$ |
Korea |
Base Rate |
2.75 (Oct 11, 2012) |
125 |
(-) 50 |
4.2 |
1.4 |
UK |
Official Bank Rate |
0.50 (Mar 5, 2009) |
0 |
0 |
4.2 |
2.7 |
US |
Federal Funds Rate |
0.0 to 0.25* (Dec 16, 2008) |
0 |
0 |
3.0 |
1.7 |
Emerging and Developing Economies |
|
|
|
|
|
Brazil |
Selic Rate |
7.25 (Oct 11, 2012) |
225 |
(-) 375 |
6.5 |
5.8 |
China |
Benchmark 1-year Deposit Rate |
3.00 (Jul 6, 2012) |
125 |
(-) 50 |
4.1$ |
2.5 |
|
Benchmark 1-year Lending Rate |
6.00 (Jul 6, 2012) |
125 |
(-) 56 |
|
|
|
|
|
(600) |
(-150) |
|
|
India |
Repo Rate |
8.00 (Apr 17, 2012) |
375 |
(-) 50 |
9.3$ |
9.5$ |
|
|
|
(100) |
(-175) |
|
|
Indonesia |
BI Rate |
5.75 (Feb 9, 2012) |
(-) 50 |
(-) 25 |
3.8 |
4.3 |
Philippines |
Reverse Repurchase Rate |
3.50 (Oct 25, 2012) |
50 |
(-) 100 |
4.2 |
2.9 |
|
Repurchase Rate |
5.50 (Oct 25, 2012) |
50 |
(-) 100 |
|
|
Russia |
Refinancing Rate |
8.25 (Sep 14, 2012) |
(-) 275 |
25 |
6.8$ |
6.5$ |
South Africa |
Repo Rate |
5.00 (Jul 20, 2012) |
(-) 150 |
(-) 50 |
6.1 |
5.7 |
Thailand |
1-day Repurchase Rate |
2.75 (Oct 17, 2012) |
200 |
(-) 50 |
3.5 |
3.6 |
*: Change is worked out from the minimum point of target range. #: Q4 (Oct–Dec).
$: November.
Note: Figures in parentheses in Column (3) indicate the effective dates when the policy rates were last revised. Figures in parentheses in
Columns (4), and (5) indicate the variation in the cash reserve ratio during the period. For India, data on inflation pertain to CPI for
industrial workers (CPI-IW).
Source: Websites of respective central banks/statistical agencies. |
VI.6 The near-term outlook on global crude
oil prices indicates a softening bias as many of
the factors that led to lower crude prices in 2012
continue to play out. While continued slow
growth of AEs and EMDEs is expected to keep
demand subdued, the prospects of improved
production from a number of oil-producing
economies along with a possible step-up in
shale oil and gas production could keep overall
demand-supply conditions in favour of lower
price levels. However, a major decline in oil prices seems unlikely given the tight demand-supply
balance, offsetting pressure from QE
and the risks of geo-political tensions further
feeding into oil prices.
VI.7 International food prices moderated
in recent months from the sudden spike
witnessed in Q2 of 2012-13 following severe
droughts this year in the US, a large part of
Europe, central Asia and Australia. According
to the Food and Agricultural Organization
(FAO), the shortfall in global production of
cereals, especially for wheat and coarse cereals
could be met by drawdown of stocks. Despite
some moderation, the current level of food
prices remain significantly high compared
to historical levels and food prices remain
extremely vulnerable to shocks induced by
weather-related disturbances, which have
increased in the recent period.
Headline inflation moderated, but
consumer price inflation remained high
VI.8 Headline Wholesale Price Index (WPI)
inflation (y-o-y) in India moderated from
8.1 per cent in September 2012 to 7.2 per
cent (provisional) in December 2012. The
moderation in inflation during Q3 of 2012-13
was faster than expected during the second
quarter review. Vegetable and fruit prices
declined as the south-west monsoon revived
in the latter half. The moderation was also
driven by a decline in the prices of freely-priced
fuel products and metals in line with
some moderation in their global prices. A
range-bound exchange rate further helped this
course. Moreover, the indirect impact of the
diesel price hike in September 2012 remained
contained, indicating that firms did not pass on
rising input costs to output prices on account
of weak demand conditions.
VI.9 The build-up in price pressures seems
to have tapered off in recent months, as the
headline WPI remained almost flat (Chart
VI.2). The momentum of price changes, as
indicated by the 3-month moving average
seasonally adjusted month-over-month
changes, also indicate significant moderation.
The financial year build-up of inflation during
2012-13 (up to December 2012) indicates that
the price pressures that were building up in the
initial months have eased significantly since September 2012, as prices remained range-bound
in all the three major groups of the WPI
(Chart VI.3).
|
VI.10 Though headline inflation moderated
somewhat, price increases for items under
administered prices have been much higher than
those for freely-priced products in the recent
period (Chart VI.4). Moderation in inflation,
commensurate with slowdown in growth, is
getting constrained by suppressed inflation
coming into the open with administered price
revisions, especially on fuel products such as
diesel and electricity. Though such revisions
add to near-term price pressures, they are
desirable from a medium-term price stability
objective, as suppressed inflation could lead to
fiscal costs in terms of mounting subsidies that
could turn inflationary.
Food inflation remains persistent as new
drivers emerge
VI.11 Food inflation continued to remain high
as new drivers of food inflation emerged (Chart
VI.5). With the late revival of the monsoon,
prices cooled off, especially for vegetables
and fruits. Price pressures, however, continued
to remain significant for cereals and pulses,
with financial year build-up of cereals inflation
at 16 per cent and pulses at 19 per cent (up
to December 2012). It may be noted that the
impact of the delayed and skewed south-west
monsoon was significant on the production of
cereals and pulses. Inflation in protein-rich
food items remained elevated, notwithstanding
some moderation in recent months.
VI.12 Manufactured food products inflation
also remained near double digits, as price
increases were significant in sugar, grain mill products, edible oils and oil cakes. The
increase in edible oil and oil cake prices could
be attributed to significant increases in oilseeds
prices in the recent period. Though there has
been some moderation in December 2012,
y-o-y price increases in oilseeds remain high
at 29 per cent. The increase in the price of oil
cake, used as a fodder, could spill over to milk
prices.
VI.13 Persistent high food inflation has
emerged as a major challenge for inflation
management. There has been a significant
increase in the cost of production in agriculture,
driven largely by the increase in wage costs,
which has also resulted in higher minimum
support prices. Also, the changing pattern of
consumption in favour of protein-rich items
has not been matched by supply elasticities,
which add to price pressures in these products.
Augmenting supply capacities and integrating
the supply chain by removing inefficiencies
could be critical in achieving the goal of stable
food prices.
Moderate decline in fuel inflation aided
by rupee appreciation, but suppressed
inflation persists
VI.14 The revision in diesel prices by ` 5 per
litre in September 2012 led to fuel inflation
reverting to double digits. However, in October
and November 2012, prices of freely-priced
fuel products declined aided by a stronger rupee and some decline in international crude
oil prices. In December 2012, there was a
marginal increase owing to higher bitumen
prices.
VI.15 The revision in administered fuel prices
and some decline in freely-priced fuel product
prices led to partial closing of the gap between
the two price levels (Chart VI.6). Despite this,
the magnitude continues to remain large, which
has resulted in the build-up of under-recoveries
of the oil marketing companies (OMCs) to the
tune of `1.25 trillion during April-December
2012, of which 59 per cent was on account of
diesel.
VI.16 Given this unsustainable level of under-recoveries,
the government on January 17,
2013 allowed the OMCs to raise the retail price
of diesel in a staggered manner and to charge
bulk consumers of diesel taking supplies
directly from the installations of the OMCs at
non-subsidised prices. Accordingly, the retail
price of diesel was increased by `0.45 per litre
(excluding VAT) and the price of diesel for bulk
consumers was increased by `9.25 per litre
(excluding VAT) from January 18, 2013. The
government also decided to raise the number
of subsidised LPG cylinders per customer from
6 to 9 in a financial year. While the increase in
diesel prices could lead to higher price levels
in the near-term, the reduction in fiscal burden
as prices get adjusted would help in medium-term
inflation management.
|
VI.17 High domestic fuel inflation at a time
when global fuel prices remained range-bound
reflects the role that administered prices play
in shaping the inflation trajectory. For most
periods, inflation in administered fuel products
remained well below the freely-priced
products under the fuel group, contributing
to suppressed inflation. Now, revisions of
administered prices are driving up fuel inflation
at a time when freely-priced products show a
significant decline in inflation, thereby making
fuel inflation more persistent (Chart VI.7).
VI.18 Though global crude price (Indian
basket) declined by about 2 per cent in dollar
terms during April-December 2012 compared
to the corresponding period in the previous
year, in rupee terms it increased by about
13 per cent, owing to the depreciation of the
rupee. Administered price revisions were much
lower than the increase in global prices, which
further increased the subsidy burden. This had
also limited the demand adjustments to price
and exchange rate signals, thereby leading to
a widening of the current account deficit (see
Chapter III for details). The recent revision in
diesel prices could be expected to correct some
of these imbalances.
Core inflation pressure has eased and is
likely to remain subdued amidst the
slowdown
VI.19 Non-food manufactured products
inflation, the indicator of generalised inflationary pressures, declined considerably
to 4.2 per cent (provisional) in December
2012 from 5.8 per cent in August 2012.
The month-over-month seasonally adjusted
annualised changes (3-month moving average)
also indicate significant moderation in price
pressures in recent months.
VI.20 The decline in inflation in this segment
reflects both the impact of the growth slowdown,
which has impacted the pricing power, as well
as the pass-through of lower commodity prices,
especially that of metals, as the exchange rate
volatility has reduced. This also indicates the
moderating impact of tight monetary policy on
inflation, which is now becoming increasingly
visible, albeit with a lag.
VI.21 Within non-food manufactured
products, ‘basic metals and metals products’
has been the major driver of the recent decline
in inflation. It is also seen that the contribution
of metals and chemicals to inflation in nonfood
manufacturing has been significantly
high in the recent period (Chart VI.8). Month-over-month price changes in most commodity
groups remained marginal, indicating that the
pressure on generalised inflation has ebbed
significantly in the recent period.
Depreciation of the rupee offset the
impact of softer global commodity prices
on domestic inflation
VI.22 The impact of softer global commodity
prices during 2012 compared to the previous year was expected to provide some comfort
on generalised inflation, especially in
items such as metals and chemicals, that
have a significant weight in the non-food
manufactured products component of the
WPI. However, the depreciation of the rupee
offset this favourable impact for most of this
period, thereby leading to the persistence of
inflation (Chart VI.9).
Risks to inflation persist from high fiscal
deficit, if not contained
VI.23 The high level of fiscal deficit and
higher revenue expenditure by the government
may add to the inflationary process. Incomplete
pass-through of energy prices may result in
higher subsidies, which are also inflationary.
While in the present macroeconomic scenario
of below-trend growth the risks to inflation
from the fiscal deficit may not be visible in the
near term, the medium-term inflationary impact
cannot be overlooked. Empirical estimates
indicate that the fiscal deficit significantly
contributes to inflation in the long run. There
is, therefore, a need to move towards further
fiscal consolidation.
Persistent wage inflation pressures may
constrain inflation moderation
VI.24 Recent trends in rural wages indicate
that the pace of increase in rural wages
moderated from a peak of about 22 per cent
(y-o-y) in August 2011 to about 18 per cent in November 2012. This, along with an increase
in inflation in rural areas in recent months, led
to a decline in real wage growth to about 6.5
per cent in November 2012. Though a rapid
increase in wages (both nominal and real)
has been a common phenomenon during the
current high inflation period, a comparison
with the previous period (2002-07) reveals that
a significant increase in real wages occurred
only in the recent period (Chart VI.10).
Empirical estimates of causality between
wages and inflation in rural areas show that in
the recent period causality ran from wages to
prices, indicating that increase in real wages
has been feeding into the cost of production
and also sustaining demand, thereby leading
to higher prices. State-specific factors also
play a major role in wage-price dynamics as
is evident from the large variation in inflation
and wage growth in rural areas across major
states (Chart VI.11).
|
VI.25 There is also evidence that increasing
wage costs are a source of concern even in
the organised sector. Private sector surveys
indicate that wage increases in India are much
higher than in other EMDEs. In the private
corporate sector, the increase in staff costs
remained at double digits, indicating persistent
pressure from wage costs (see Chapter II).
Divergence between CPI and WPI
inflation persists
VI.26 Even as WPI inflation moderated,
inflation, as per the all-India new Consumer Price Index (CPI-combined: rural+urban),
remained elevated, with inflation for December
2012 at 10.6 per cent. Double-digit food
inflation in the new CPI, which has a higher
weight for food than the WPI, continues to
keep CPI inflation above the WPI. Also, in
the new-CPI, excluding the food and fuel
component, inflation remains much higher
than the WPI (Table VI.2). This could be partly
because the WPI does not cover services and
rent, whereas both are covered in the new CPI.
In terms of contribution to inflation, the pattern
remained consistent in the recent period with
the food and beverage group being the major
driver. The persistence of high CPI inflation
compared to the headline inflation moderation
is a source of concern.
Inflation remains divergent between rural
and urban areas across product groups
VI.27 Though the overall inflation in rural and
urban areas remains close (at 10.7 and 10.4 per
cent, respectively, in December 2012), there
is wide variation in inflation across various
commodity groups (Chart VI.12). In the
case of vegetables, condiments & spices and
milk, inflation is higher in rural areas than in
urban areas, even though rural areas are the
producers of these products. In urban areas, cereals, pulses, prepared meals, sugar and some
miscellaneous goods and services report higher
inflation. It is also observed that food prices
are more volatile in urban areas than in rural
areas. The role of supply-chain inefficiencies
merits closer analysis in this context.
Table VI.2: WPI and New CPI (Combined) Inflation |
|
Food |
Fuel |
Excl. Food and Fuel |
Overall |
WPI |
New CPI |
WPI |
New CPI |
WPI |
New CPI |
WPI |
New CPI |
1 |
2 |
3 |
4 |
5 |
6 |
7 |
8 |
9 |
Weight |
24.3 |
47.6 |
14.9 |
9.5 |
60.8 |
42.9 |
100.0 |
100.0 |
Apr-12 |
9.3 |
10.1 |
12.1 |
11.2 |
5.4 |
10.2 |
7.5 |
10.3 |
May-12 |
8.9 |
10.5 |
11.5 |
10.7 |
5.8 |
10.1 |
7.5 |
10.4 |
Jun-12 |
9.1 |
10.8 |
12.1 |
10.3 |
5.6 |
8.9 |
7.6 |
9.9 |
Jul-12 |
9.0 |
11.6 |
8.4 |
7.3 |
6.5 |
8.5 |
7.5 |
9.9 |
Aug-12 |
9.3 |
12.1 |
8.7 |
7.5 |
7.1 |
8.3 |
8.0 |
10.0 |
Sep-12 |
8.8 |
11.7 |
12.0 |
7.2 |
6.6 |
8.1 |
8.1 |
9.7 |
Oct-12 |
7.8 |
11.5 |
11.6 |
7.6 |
5.8 |
8.4 |
7.3 |
9.8 |
Nov-12 |
9.0 |
11.8 |
10.0 |
7.4 |
5.6 |
8.4 |
7.2 |
9.9 |
Dec-12 |
10.4 |
13.1 |
9.4 |
8.2 |
5.0 |
8.4 |
7.2 |
10.6 |
Inflation moderation may be constrained
by persistent risks during 2013-14
VI.28 The current moderation in both
headline and core inflation reflects the impact
of a significant slowdown in growth and past
monetary policy measures. While the supply-side
pressure from high food prices persists,
suppressed inflation in the fuel group needs
to be passed on even at the cost of a higher
inflation reading in the short term.
VI.29 Going forward, while the likely
persistence of a high consumer price inflation
remains a concern, expected moderation in
headline WPI inflation in Q4 of 2012-13 could
improve the overall inflation scenario. Softer
global commodity prices could keep pressure
from imported inflation benign, though risks
from global commodity price volatility and
exchange rate changes cannot be ruled out.
Further moderation in food inflation would be
conditional on easing of supply pressures, as
well as improving the efficiency of the supply
chain. The revision in diesel prices announced
on January 17, 2013 and the proposed staggered
increases in the coming months will result
in higher inflation numbers in the near-term.
Price pressures can also arise from possible
adjustments in prices of coal and electricity.
Nevertheless, these steps are desirable from a
medium-term inflation management point of
view. The pressure on generalised inflation,
however, can be expected to remain muted
given the weak pricing power of firms.
Pressures from industrial raw material prices,
which had been a significant source of inflation
in non-food manufactured products in the
recent past, are also abating. However, the risks
of entrenchment of higher food inflation into
higher inflation expectations and a wage-price
spiral remain. Given these risks, the moderation
in inflation is expected to be gradual.
|
|