A higher-than-anticipated rise in prices last month surprised analysts, much like the first-quarter GDP data had less than a fortnight ago. Headline retail inflation, 7 percent year-on-year in August, did not deviate as much from the consensus, 6.9 percent, as the 13.5 percent real GDP growth did, missing forecasts including the central bank’s, by 2.5-3 percentage points. Concerns about the growth deficit have also been compounded by July’s industrial output that rose a bare 2.4 percent year-on-year.
The latest data continue the doubt if the current inflation episode has concluded. This picked up compared to July’s 6.7 percent, while there are no convincing signs of a stabilising recovery. Which side of the equation will the central bank prioritise at its review meeting this month end is complicated by macro stability considerations. There are no easy choices.
The weaker-than-expected growth in the April-June quarter showed a sequential contraction of -1.4 percent in seasonally adjusted terms that, according to the OECD, was the second-worst amongst G20 nations (overall contraction of -0.4 percent) and lagged only China’s -2.6 percent.
Net exports pulled down the most; this drag could accentuate from a further slowing of the world economy ahead. Supply-side weaknesses showed up in sequential declines in manufacturing, construction, trade, hospitality, transport, and communication services’ segments. In fact, the shrinkage in the trade, hospitality, transport category is considerable over April-June 2019, whose level it trailed at 84.5 percent with construction rising 1.2 percent.
Progress in industrial output is also best compared to April-July 2019 due to distortions in Q1:FY21 and Q1:FY22. In this year’s first quarter, industrial production has risen 5 percent above Q1:FY20, slowing to 2.1 percent in July. The use-based production data is a good gauge of consumer demand strength. Here, signs are disappointing: Consumer durables’ output contracted -7.9 percent over April-June 2019, or at 92.1 percent of its level then; non-durables’ output, which proxies lower-end consumption demand more closely, still lagged at 98.8 percent of its size in the quarter three years ago; while capital goods contracted -4.4 percent. No visible improvements were seen in July 2022 over 2019 — durables contracted -6.8 percent, non-durables -2.5 percent, and capital goods output growth of 6.5 percent was upon a -7 percent year-on-year contraction in July 2019.
Many questions surface about the recovered demand strength, if the recovery is exhausting itself even before complete restoration, of an uncertain and uneven revival as substantial parts of the services’ economy lag behind, to cite some. The growth deficit in the trade, hospitality, transport category, and weak growth of construction is significant from the standpoint of aggregate demand — these are comparably informal economic segments employing large numbers of un- and semi-skilled persons; diminishment over a three-year period could reflect permanent damage or lowered potential output. In this context, the strong persistence of inflation, elevated unemployment and anecdotal evidences of K-shaped recovery, create uncertainty about the size of the output gap.
The August inflation data shows fairly broad-based price pressures, not restricted to food prices subject to much intervention and manipulation. Retail food and beverages inflation accelerated to 7.6 percent annually, that in cereals jumped to 8.6 percent from 6.8 percent in both categories in July; the impact of lower acreage, insufficient buffer stocks to influence prices, and incentives needs to be seen.
Core inflation is unmoving around 6 percent, prices of both goods and services components rose in August, the sequential momentum in different core-inflation measures was either firm or rose, services’ inflation shows signs of comeback pressures, while firms continued to pass-on costs and ease their burdened margin. Wholesale inflation data released on September 14 showed it moderating to 12.41 percent in August 2022 compared to 11.64 percent one year ago, from 13.93 percent in July and 16.23 percent in June. It remains high and in double-digit nonetheless; coupled with pipeline pressures, prospective passthroughs of costs to retail levels with the inception of festival demand this quarter and beyond cannot be ruled out.
The feeling that inflation is under a firm grip owes a lot to the passed peak of 8.3 percent in April that hasn’t resurfaced. But that does not diminish the fact that 7 percent inflation is way above target, that it looks neither low nor stable; and that inflation surprises, in both directions, cannot be ruled out. This doubts if the present inflation incident is durably over.
The trade-off is more complicated because the external environment has turned much riskier. The US central bank is expected reacting aggressively as US inflation and demand both remain strong; a 75-basis point increase is expected at the FOMC meeting on September 20-21.
Preserving macroeconomic stability at a time of extraordinary and fundamental realignments assumes importance, especially for the currency. Although supporting a recovery may have precedence, a growing divergence in monetary policy, negative real rates, would not be easy to sustain in a hazardous environment of unknown duration. Most expect the RBI, which will also revise its growth forecast the second time this year, to adjust the repo rate by 35-50 basis point this month. We should know soon.