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The core debate

Rajan: What next?

Mumbai, Jan. 15: The RBI is widely expected to stand pat on interest rates when governor Raghuram Rajan huddles with his monetary policy advisers on January 28, drawing some comfort from the fact that inflation rates measured on the both the price index gauges — the WPI and the CPI (combined) — have tumbled more than anticipated.

But the worry is that core inflation has started to rise —or has it?

On Wednesday, the economists were locked in a mathematical quibble over core inflation and its exact trajectory.

One set believes that core inflation is down as well, arguing that if we take the top-down approach — i.e. calculate core inflation by subtracting food and fuel from headline inflation — it yields a rate of 7.94 per cent based on the CPI (combined) which is lower than the 7.96 per cent logged last November.

The other group insists on calculating core inflation using a “bottom-up” exclusion approach — i.e. calculate core inflation by adding all components except food and fuel — which yields a number of 8.05 per cent.

“Mathematically, these two numbers should not be different but (1) rounding off indices and re-calculation of core inflation from the same, and (2) weightages also being rounded off can lead to differing results,” say Indranil Pan and Suvodeep Rakshit of Kotak Economic Research.

But it is this quibble that’s kept every one guessing on whether the RBI will prefer to hold rates now only to raise it a few weeks later. Pan and Rakshit said such a minute analysis of core inflation was totally unnecessary.

“We believe that the markets should take a cue from the CPI outturn that (1) headline inflation is lower (2) food inflation is lower and (3) core inflation remains unchanged. Based on our current expectation on headline and core WPI inflation, we expect the RBI to maintain status quo on January 28,” they added.

Core CPI inflation has hovered around 8 per cent for the past three months, a level that Rajan deems as uncomfortably high.

Data showed that core WPI inflation had also inched up to around 2.8 per cent last month from 2.66 per cent in November.

After raising interest rates twice since September, the RBI left rates steady last month fearing that it would hurt the economy. Those fears were not misplaced as industrial output shrank in November and merchandise exports contracted last month.

In its December policy review, the RBI had said if the expected softening of food inflation did not materialise and translate into a significant decline in headline inflation in the next round of data releases, it would act “including on off-policy dates if warranted”.

Earlier this week, Deepak Mohanty, executive director of the Reserve Bank, had drawn attention to the erratic behaviour of food inflation since the midľ1990s, which didn’t seem to be linked either to the pace of GDP growth or the impact of the monsoon.

He said, “Average food inflation declined to 3.8 per cent per annum during the eight-year period 2000-08 from 7.1 per cent per annum in the second half of the 1990s despite higher GDP growth of 7.2 per cent per annum as against 6.7 per cent in the preceding period.”

Mohanty added that during the five-year period between 2008-09 and 2013-14, average food inflation rose sharply to 10.3 per cent per annum and “ it has remained persistent”.

“There are several other explanations such as that global food prices also rose and our exchange rate depreciated which exacerbated domestic food inflation. But subsequent moderation in global food prices has not dampened our food inflation. Of course food inflation has come off its peak, but its persistence around double digit level suggests that that there must be some thing more fundamental at play.”

But the general view was that the RBI would hold interest rates steady again. “We believe that the RBI is likely to remain cautious in view of the uptick in core inflation. We expect the RBI to hold monetary policy rates during its January 28 policy review,” said Bhupal Gursale of Angel Broking.

 
 
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