Inflation is trending lower but growth is the real challenge

CPI inflation at 4.06%

The fall in CPI inflation in the last two months has been much quicker than expected. From a level of almost 7.5%, the CPI inflation has tapered very close to the 4% mark in Jan-21. That has been largely led by a steep fall in food inflation, which was expected after a robust Kharif output and expectations that even the Rabi crop would do much better than anticipated. The surge in supply combined with supply chain measures addressed the problem of food prices to a large extent. However, another inflation challenge still persists.

Core inflation holds the key

Core inflation is the inflation that is the residual number excluding food and fuel inflation. The reason core inflation is important is that it is the sticky part of inflation that is non-cyclical. Even the Economic Survey this year had pointed that inflation focus would have to shift to core inflation instead of pure headline inflation. Despite the sharp fall in CPI inflation to 4.06%, the core inflation is still stuck at around 5.7%. That means; the structural issues pertaining to prices are still there; and that is a worry!

IIP growth still elusive

Along with the CPI inflation number for Jan-21, the MOSPI also announced the IIP for the month of Dec-20. IIP comes with a lag of one month and is a very important lead indicator of GDP growth. To be fair, IIP has picked up from being in the negative zone into the positive zone but that is still not encouraging enough. IIP is dominated largely by the manufacturing sector to the tune of over 75% and is the best barometer of the industrial recovery. The 1% growth in IIP is a good sign but a much sharper pick up in IIP is required if India has to get to GDP growth of 11% in FY22 as estimated by the RBI. That has policy implications on fiscal and the monetary front as options may be running out.

Policy challenges remain

The lower level of inflation can become a good justification for stable repo rates and an accommodative monetary policy but that clearly has its limits. In the last few months, the focus has shifted to boosting GDP through fiscal measures. While such measures do have their time lag, the government will need to show action in the IIP numbers to be able to justify its $400 billion stimulus program and a yawning 9.5% fiscal deficit. The RBI has underlined the need to boost GDP growth above all else. However, such assumptions have limits. The IIP needs to see better traction to justify the fiscal deficit aggressiveness.