[T.S.R:18018] CLSA: India's Inflation Is Getting Entrenched

 

The mood at CLSA 14

th India Forum this week has been much more subdued than in recent

years. This is no surprise. The Indian stock market has underperformed this year as it has

discounted Asia's most aggressive monetary tightening cycle. Thus, the MSCI India Index has

fallen by 29% in US dollar terms so far in 2011, compared with a 15% decline in the MSCI AC

Asia Pacific ex-Japan Index. This is the worst relative performance since 2008.

 

Meanwhile, there remains no concrete evidence that inflation has peaked, most particularly in

the non-food area. Still the RBI has, for now at least, gone on hold while the hope is that the

base effect should bring down the overall level of inflation from the December month. Headline

WPI inflation stood at 9.73%YoY in October, almost unchanged from 9.72% in September.

While non-food manufactured goods WPI, a proxy for core inflation, also remained unchanged

at 7.6%YoY. 

 

Still reassurance on the inflation front will only come with confirmation from the data. This is

because inflationary pressures have proved much more intense in this cycle than either the

central bank or private-sector economists were predicting. The main reason why is because

non-food core inflation did not come down with food prices over the past seven quarters, as

had been expected. This was taken as confirmation by the central bank that inflation

expectations were becoming entrenched. Hence the renewed tightening in recent months.

 

Why has inflation proved so stubborn? The best explanation heard this week was described to

GREED & fear

as "force-fed trickle down". The trickle down refers to the fact that labour has

found itself with much greater bargaining power in a country where unskilled workers have

generally been viewed as having no pricing power whatsoever. The "force-fed" nature of the

trickle down refers to the Congress-led government's policies consciously seeking to

redistribute income, be it the Mahatma Gandhi National Rural Employment Guarantee Act

(MGNREGA) or the Minimum Support Price (MSP) scheme.

 

If this is the best explanation for the stubbornly entrenched pressures, the macroeconomic

issue is whether Congress' populist initiatives have led to a positive one-off redistribution of

income or whether they have set off a self-feeding inflationary spiral. The Reserve Bank of

India has stepped in, clearly, in the aim of avoiding such a spiral. But the central bank's

problem is that the level of development in the Indian economy means that consumption

patterns are not particularly influenced by monetary tightening, save for relatively affluent

areas of consumption such as car sales and mortgage finance which impact that part of the

population, say 300m at most, which might be described as the aspiring bourgeoisie.

 

This is why monetary tightening in India is a rather blunt tool in the current Indian

macroeconomic context. For it is more likely to hit investment than consumption, as is now

happening. Yet investment is what is needed to deal with the supply constraints which remain

the major impediment to Indian growth and which, incidentally, are also a contributor to

inflationary pressures. Yet if this is the case, it is also a reality that the RBI has felt obliged to

continue its tightening in recent months precisely because of the failure of the government to

play its part and take more contractionary action on the fiscal front. Indeed the central bank

has stated as much in its policy statements.

 

If this is the state of play, the reality for now is that the central bank has gone on hold and is

hoping, like everyone else, that inflationary pressures will now subside as predicted. This is

because it is increasingly mindful of growth issues, most particularly given the deteriorating

external context. It is also as aware as everyone else that monetary tightening is a blunt tool in

India.

 

This leads

GREED & fear to the other factor in the Indian story which is complicating what

otherwise remains one of the world's best long-term growth stories. That is the sharp slowdown

in investment projects, most particularly in the infrastructure sector. This is much more severe

than what was experienced after the 2008-2009 crisis, as can be seen in the attached charts

 

Thus, according to the Centre for Monitoring Indian Economy (CMIE),

growth in investment projects under implementation slowed from 40%YoY in September 2010

to 9% in September 2011. While new investment project announcements during the July-

September quarter fell by 30%YoY to Rs2.6tn, the lowest level since April-June 2009.

 

 

 

 

Safe Harbor Statement:

Some forward looking statements on projections, estimates, expectations & outlook are included to enable a better comprehension of the Company prospects. Actual results may, however, differ materially from those stated on account of factors such as changes in government regulations, tax regimes, economic developments within India and the countries within which the Company conducts its business, exchange rate and interest rate movements, impact of competing products and their pricing, product demand and supply constraints.

 

Nothing in this article is, or should be construed as, investment advice.

 

 

 

 

 

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