2011-12 was marked by strong inflationary pressures that began easing only in December.
The recent fall in inflation has been largely supported by transitory factors such as a seasonal
decline in vegetable prices and favourable base effect. However, demand moderation, reflected
in the dampening of the pricing power of producers has also played a role. Meanwhile, more
permanent supply-side responses, for example in the dairy sector, have just begun to take shape.
Going forward, inflation in 2012-13 is likely to remain around current levels. Importantly, the
near-term inflation trajectory is subject to significant upside risks, in particular from high oil
prices and unsustainable levels of suppressed inflation, the lagged pass-through impact of rupee depreciation, higher freight rates and taxes, sustained wage pressures, and the structural nature of protein-food inflation.
Central banks eased further with larger
risks to global growth even as global
inflation risks remain
VI.1 Weak global growth momentum kept global inflation risk under check during 2011.
However, global metal prices, after softening
for large part of the year firmed up during Q4
of 2011-12. Global crude prices that surprised
on the up for most of 2011-12, not only
remained elevated but also increased
significantly during Q4 of 2011-12. As a result,
upside risks persist. Inflation divergence between emerging and developing economies (EDEs) and advanced economies (AEs) also
persisted. As EDEs have a higher share of commodities in their consumption baskets,
higher commodity prices are likely to exert larger pressure on inflation in EDEs than on
AEs.
VI.2 The uncertainty in the global growth
outlook and volatility in commodity prices impart considerable uncertainty on the near-
term global inflation outlook. Incomplete deleveraging of the private sector and the urgency of fiscal consolidation in many parts of the AEs to reduce the looming debt burden may
further weaken demand-side risks to inflation.
On the other hand, sustained easy monetary
conditions and supply disruptions in commodity
markets pose significant upside risks.
VI.3 The monetary policy focus across countries, both AEs and EDEs has changed course significantly since mid-2011 as concerns about sustaining the recovery of economic growth in AEs and strength of growth impetus in EDEs increasingly weighed in the monetary
policy stance adopted by the central banks.
Central banks in AEs have generally reduced
their policy rates or kept them at near-zero
levels while the ECB also resorted to long-term repurchase operations (LTRO). The central banks of EDEs, which were earlier raising
policy rates to control inflation, turned course and reduced policy rates and eased liquidity
conditions to address growth concerns (Table VI.1).
Upside risks to global commodity prices are significant in 2012-13
VI.4 Global commodity price pressures,
except those on crude oil, generally remained
subdued for most of 2011-12 before accelerating
in Q4 (Chart VI.1). Global crude oil prices also
increased significantly in Q4 of 2011-12 as geo-
political tensions and concerns about supply
disruptions contributed to price pressures. The
path of global commodity prices in 2012-13 is
uncertain. On current assessment, during the year, Indian basket crude oil prices could
average around the current levels of about US$
120/barrel but both upside and downside risks
to this projection remain large. The slow growth
in AEs and the deceleration in China coupled
with the fact that commodity prices have hardened significantly in the past two years provide some hope that high commodity prices
may correct somewhat during the course of the year. However, the global liquidity glut and the
financialisation of global commodity markets constitute a significant upside risk (see V.23-V.24).
Table VI.1: Global Inflation Indicators |
Country/ Region |
Key Policy Rate |
Policy Rate
(as on April 13, 2012) |
Changes in Policy Rates
(basis points) |
CPI Inflation
(y-o-y, per cent) |
Sep15, 2008
to Aug.
23,
2009 |
Aug
23,
2009 to
Oct 25,
2011 |
Since
Oct 25,
2011 |
Mar-11 |
Mar-12 |
1 |
2 |
3 |
4 |
5 |
6 |
7 |
8 |
Advanced Economies |
Australia |
Cash Rate |
4.25 (Dec. 7, 2011) |
(-) 400 |
175 |
(-) 50 |
2.7# |
3.1# |
Canada |
Overnight Rate |
1.00 (Sep. 8, 2010) |
(-) 275 |
75 |
0 |
2.2$ |
2.6$ |
Euro area |
Interest Rate on Main Refinancing Operations |
1.00 (Dec. 14, 2011) |
(-) 325 |
50 |
(-) 50 |
2.7 |
2.6 |
Japan |
Uncollateralised Overnight Call Rate |
0.0 to 0.10 (Oct. 5, 2010) * |
(-) 40 |
(-) 10 |
0 |
-0.5$ |
0.3$ |
UK |
Official Bank Rate |
0.50 (Mar. 5,2009) |
(-) 450 |
0 |
0 |
4.4$ |
3.4$ |
US |
Federal Funds Rate |
0.0 to 0.25 (Dec.16,2008)* |
(-) 200 |
0 |
0 |
2.7 |
2.7 |
Developing Economies |
Brazil |
Selic Rate |
9.75 (March 8, 2012) |
(-) 500 |
275 |
(-)175 |
6.3 |
5.2 |
India |
Repo Rate |
8.50 (Oct. 25, 2011) |
(-) 425 |
375 |
0 |
8.8$ |
7.6$ |
|
|
|
(-400) |
(100) |
(-125) |
|
|
China |
Benchmark 1-year Deposit Rate |
3.50 (Jul. 7, 2011) |
(-) 214 |
100 |
0 |
5.4 |
3.6 |
|
Benchmark 1-year Lending Rate |
6.56 (Jul. 7, 2011) |
(-) 241 |
100 |
0 |
|
|
|
|
|
(-200) |
(600) |
(-100) |
|
|
Indonesia |
BI Rate |
5.75 (Feb. 9, 2012) |
(-) 275 |
0 |
(-) 75 |
6.7 |
4.0 |
Israel |
Key Rate |
2.50 (Jan. 23, 2012) |
(-) 375 |
275 |
(-) 75 |
4.2$ |
1.7$ |
Korea |
Base Rate |
3.25 (Jun 10, 2011) |
(-) 325 |
125 |
0 |
4.1 |
2.6 |
Philippines |
Reverse Repo Rate |
4.00 (March 1, 2012) |
(-) 200 |
25 |
(-) 50 |
4.8 |
2.6 |
|
Repo Rate |
6.00 (March 1, 2012) |
(-) 200 |
25 |
(-) 50 |
|
|
Russia |
Refinancing Rate |
8.00 (December, 26 2011) |
(-) 25 |
(-) 250 |
(-) 25 |
9.5$ |
3.7$ |
South Africa |
Repo Rate |
5.50 (Nov. 19, 2010) |
(-) 500 |
(-) 150 |
0 |
3.7$ |
6.1$ |
Thailand |
1-day Repurchase Rate |
3.00 (Jan. 25, 2012) |
(-) 250 |
225 |
(-) 50 |
3.1 |
3.5 |
*: Change is worked out from the minimum point of target range. #: Q4 of 2011. $: February.
Note: Figures in parentheses in column (3) indicate the effective dates when the policy rates were last revised.
Figures in parentheses in column (4, 5 & 6) indicate the variation in the cash reserve ratio during the period.
For India, data on inflation pertain to CPI for Industrial Workers.
Source: Websites of respective central banks/statistical agencies. |
|
|
Headline inflation in India softened in line with projected trajectory
VI.5 After almost two years of sustained high
inflation, inflation started declining from November 2011. Headline inflation, which was
at 10 per cent in September 2011, declined to
6.6 per cent by January 2012. Though inflation
increased marginally in February 2012, the momentum indicators, as measured by 3-month
moving average seasonally adjusted month-
over-month changes, suggest softening of price pressures (Chart VI.2).
VI.6 In terms of contribution to overall inflation, the decline has been prominent for food (Chart VI.3). The contribution of non-food
manufactured products has declined gradually
over the recent months alongside the deceleration
in growth momentum. The contribution of the
fuel group to overall inflation remains high,
despite the current levels of domestic petroleum prices not fully reflecting global market prices.
Primary food inflation reversed after the
sharp decline as transitory effects waned
VI.7 The sharp decline in primary food
inflation witnessed during Q3 of 2011-12 was
the result of favourable base effect and a more
than expected seasonal decline in vegetable prices. As was assessed in the previous edition
of this document, the decline of food inflation
to negative territory was a temporary
phenomenon and primary food inflation increased sharply from -0.5 per cent in January
2012 to 6.1 per cent in February 2012 (Chart
VI.4). Both the waning base effect and the increase in prices of vegetables from a seasonal trough contributed to the rebound in food
inflation.
Although protein inflation declined in 2011-12, structural demand-supply imbalances keep it high
VI.8 On a yearly average basis, protein
inflation softened to about 10 per cent in 2011-
12 (April-February) after remaining close to 20
per cent in the preceding two years. However,
it still remains high and has been rising steadily
since August 2011 (Chart VI.5). High inflation
in protein-rich food items along with significant upward revisions in Minimum Support Prices
(MSP) and increases in rural wages in excess of inflation have imparted upward push to food
inflation. Besides the lagged supply response,
input cost pressures have led to sustained
double-digit inflation in protein-rich food items.
Recognising the importance of supply-
augmenting measures to address the concerns
about food inflation, the government in the Union Budget for 2012-13 announced a number of measures to augment supply and improve storage and warehousing facilities. These schemes include a `22 billion project to improve productivity in the dairy sector, and a national
mission for ‘Food Processing’, apart from provisions to add storage capacity for foodgrains.
These supply-side measures will help in
containing food inflation but the overall benefits will be realised only with a lag.
Energy prices likely to remain a significant source of inflation
VI.9 A major concern on the inflation front continues to be high fuel prices driven by the increase in international oil prices. Domestic fuel group inflation that captures changes in
energy prices has been in double-digit for 25
successive months (up to February 2012). The increase in fuel group inflation has largely been
driven by increase in prices of mineral oils,
besides moderate increases in coal and
electricity prices. Most importantly, suppressed
inflation in administered prices continues to
remain substantial and significant increases in crude oil prices in Q4 of 2011-12 and exchange rate depreciation in H2 of 2011-12 have amplified the magnitude of suppressed inflation
(Chart VI.6). Currently, the estimated under-
recoveries by domestic oil marketing companies for diesel and PDS kerosene are `14.36 and
`31.04 per litre, respectively, and `570.50 per cylinder for domestic LPG. The Union Budget for 2012-13 has budgeted a lower amount towards fuel subsidy; if subsidies have to be contained within the budgeted limits, it would
require a significant revision in administered
fuel prices, which would lead to spike in price levels. This would translate into higher price level in the near-term but inflation would later moderate and suppressed inflation pressures would also wane. Therefore, while fuel inflation
risks remain significant in the near term, even
if global crude prices ease moderately from current levels, the deregulation of fuel prices is a desired policy option.
|
|
VI.10 Apart from oil prices, another source of risk to inflation is the possible upward revision
in coal prices. Electricity prices are also likely
to come under pressure from higher input costs (Chart VI.7).
Generalised price pressures soften as
growth deceleration eases demand
VI.11 After remaining over 7 per cent for 11
consecutive months, non-food manufactured
products inflation started to decline from January 2012 and reached 5.8 per cent by February 2012 as growth deceleration dampened
demand pressures. Month-over-month increases in prices have moderated in recent months (as
per the 3-month moving average SAAR) (Chart VI.8). The increase in railway freights and the
rollback of an earlier cut in excise duty (as part
of the Railway Budget and Union Budget,
respectively), however, will increase cost pressures, which could lead to an increase in
the prices of non-food manufactured products,
thereby increasing inflation in the short-term.
The pass-through of these fiscal measures over
time do not constitute an upside risk to the medium-term inflation trajectory.
|
VI.12 Pressure from input costs is yet to soften
and input cost increases continue to be much
higher than increases in output prices, as is borne out by the HSBC Markit Purchasing
Managers Index (PMI) for input and output prices (Chart VI.9). This could further squeeze
profit margins in an environment of weak
demand.
Exchange rate pass-through risks remain
significant
VI.13 Since August 2011, the depreciation of
the rupee has emerged as a major upside risk to
the inflation trajectory (Table VI.2). Even
though global commodity prices moderated, the sharp depreciation of the rupee between August and December 2011 more than offset the impact of declining commodity prices. Since January
2012, the rupee has appreciated while international commodity prices have firmed up.
Apart from the commodity price outlook,
exchange rate movements have added
uncertainty to the inflation trajectory. Pass-
through of both depreciation of the exchange
rate and higher oil prices have been partial so
far due to suppressed inflation in the fuel group.
Wage pressures in both rural and urban
areas are yet to soften
VI.14 The pressure on generalised inflation
from sustained increase in wage costs has been
one important characteristic of the recent high
inflation episode. Wage increases for unskilled
labourers in rural areas continue to be at a rate faster than the comparable rate of inflation (i.e.,
CPI-RL) (Chart VI.10). There are, however,
significant divergences across major States (Chart VI.11). Similarly, in the formal sector,
the analysis of company finance data suggests that growth in staff costs remain firm (Chart VI.12). Private market surveys also suggest relatively higher rates of increase in salaries and perks in the organised sector in India compared with other countries. A host of factors could explain the increase in wages, including
high inflation, withdrawal of the labour force with increased participation in education and government schemes such as MGNREGS.
Though rising real wages could enhance welfare, the inflationary implications of high
increases in wages have to be managed to
sustain the benefits from high growth.
Table VI.2: Comparative Movement of Oil Price and Exchange Rate Since July 2011 |
|
July 2011 |
December 2012 |
Fortnight
March 16-31,
2012 |
Change in per cent (July 2011-December 2012) |
Change in per cent (December 2012-March 16-31, 2012) |
1 |
2 |
3 |
4 |
5 |
6 |
Crude oil Indian Basket (US$) |
112.5 |
107.2 |
123.2 |
-4.7 |
14.9 |
Exchange Rate (`/US$) |
44.4 |
52.7 |
50.8 |
18.6 |
-3.6 |
Crude Indian Basket (`) |
4995.8 |
5646.8 |
6253.1 |
13.0 |
10.7 |
Note: The composition of Indian Basket of Crude Oil represents the Average of Oman & Dubai for sour grades and Brent (Dated) for sweet grade in the ratio of 67.6:32.4.
Source: Petroleum Planning and Analysis Cell. |
New CPIs show sustained increase in price levels
VI.15 Annual inflation according to the new CPI became available for the first time in
January 2012. The latest data show that inflation was higher in urban areas (9.5 per cent) than in rural areas (8.4 per cent) leading
to all-India inflation of 8.8 per cent for February
2012 (Table VI.3). While part of the higher CPI
inflation reflects the high weight of food in the consumption basket (49.7 per cent for all-
India), stronger price pressures in services included in the CPI basket point to the persistence of generalised inflation. This is also
reflected in the all-India CPI excluding food
and fuel inflation being high at 10.1 per cent as compared to the WPI excluding food and fuel inflation of 7.0 per cent for February 2012.
Once longer time series information on CPI inflation becomes available, trends in services prices will improve the assessment of the generalised inflation process. CPI- Industrial Workers inflation was at 7.6 per cent while CPI-Rural Labourers and CPI-Agricultural Labourers inflation were at 6.7 and 6.3 per cent,
respectively, in February 2012, which are much
lower than the inflation reported by the new CPI.
|
Table VI.3: All-India New CPI Inflation: February 2012 |
y-o-y, per cent |
Category |
Rural |
Urban |
Combined |
Weight |
Inflation |
Weight |
Inflation |
Weight |
Inflation |
1 |
2 |
3 |
4 |
5 |
6 |
7 |
General Index (All Groups) |
100.0 |
8.4 |
100.0 |
9.5 |
100.0 |
8.8 |
Food and beverages |
59.3 |
6.3 |
37.2 |
7.2 |
49.7 |
6.6 |
Fuel and light |
10.4 |
13.1 |
8.4 |
12.2 |
9.5 |
12.8 |
Clothing, bedding and footwear |
5.4 |
12.7 |
3.9 |
14.0 |
4.7 |
13.2 |
Housing |
-- |
-- |
22.5 |
13.6 |
9.8 |
13.6 |
Miscellaneous (Services) |
24.9 |
9.1 |
28.0 |
7.2 |
26.3 |
8.3 |
Inflation moderated in response to slowing
growth but upside risks remain
VI.16 The impact of the slowdown in growth
momentum on generalised inflation has been
visible as inflation in the non-food manufactured
products category receded in recent months.
However, the inflation outlook for 2012-13
needs to factor in significant upside risks. These emerge from volatile commodity prices, lagged
pass-through of the exchange rate depreciation,
sustained wage push pressures, unsustainable levels of suppressed inflation and likely sustained government spending as consolidation
is mainly due to revenue-augmenting fiscal measures. The spatial and temporal distribution
of the south-west monsoon has always been a major determinant of short-term food inflation,
while structural factors continue to play a major role in conditioning food inflation dynamics.
Recent measures announced in the Union
Budget to improve supply responses in the agriculture sector and protein-rich food are expected to yield positive results, but not immediately. Against this backdrop, monetary
policy has to recognise the need for keeping
inflation expectations anchored in an
environment of significant upside risks to
inflation, while shifting the balance of policy
to arrest the deceleration in growth momentum. |