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ET Explains: The core inflation conundrum and the ominous signs that it masks
Headline inflation plays more on the consumer's mind, but the real risks remain hidden in another realm.
The usual suspect behind mounting retail inflation is the spike in food prices led by uptick in vegetable prices. Onion prices have been on fire due to flooding in key producing states and unseasonal rainfall. While the rising headline inflation figure may play on the minds of consumers, what it masks is a key indicator that carries ominous signs of a worsening slowdown.
More than just onion prices
Retail inflation basket comprises not just food items even if they carry the maximum weight in the basket. The basket comprises many other items of consumption including services like education, health, housing among others.
The spike in retail inflation is driven by escalating vegetable prices which might be seasonal and not indicative of a long lasting trend. The unseasonal rainfall and flooding could have led to the recent spike in food prices. The Reserve Bank of India, in its October monetary policy review, said that vegetable prices may remain elevated in the immediate months but are likely to moderate as winter supplies enter the market.
The Gorilla in the room
The dwindling demand scenario is best captured by the falling core inflation which should ring alarm bells for the government. Core inflation, which excludes volatile items like food and fuel, has seen a steady decline over the last one year barring a slight bump-up in July this year owing to bullion and transport prices, which rose because of higher fuel prices.
Core inflation for the month of October was reported at 3.46 per cent. Even the wholesale core inflation slumped to -1.6 per cent in October from -1.1 per cent in September signifying tepid demand conditions and softening of commodity prices.
Higher gold price has kept the ex-food and fuel inflation from falling even further. "If one-off factors like gold prices are excluded, inflation excluding food and fuel falls below target," Dr Michael Patra of the RBI said in the Monetary Policy meet. He also said that the "underlying dynamics excluding food and fuel seem to be mirroring the growing slack in the economy".
"Inflation excluding food and fuel moderated in August, reversing the increase in the previous month; the moderation was broad-based, which more than offset the sharp increase in gold prices. CPI inflation excluding food and fuel moderated by around 90 bps between March and August 2019," RBI Governor Shaktikanta Das said.
Considering the weaker GDP print expected in second quarter and demand slackening reflected by falling core inflation, experts have called for front-loading of interest rate cut by the RBI.
Even though food inflation ticked up recently, that could be seasonal and should not take the focus off a weakening economy. Critical macroeconomic indicators like industrial production and core sector growth have fallen into the negative territory eliciting more reduction in rates by the RBi along with continued fiscal measures by the government.