‘Demand has consistently out-stripped supply’

I don’t think there is a lot of base effect at this point. Right now,monthly inflation is running ahead of the year-on-year number at 9.6 per cent. So,the momentum in inflation is much faster than what the year-on-year numbers are showing and consequently there is little or no real base effect.

At the moment,I believe,food inflation is the main driver for inflation. Yes,some of it is due to supply-side constraints but,I think,food inflation to a large extent was on the rise from early 2008. Therefore,it probably reflects the very strong underlying demand for food that has outstripped the supply. It basically reflects that with the rise in incomes,people are moving out of traditional cereals and grains into milk and poultry and high-protein diet. In a sense,it is good as it shows that growth has trickled down. But at the same time,it also shows that India is chronically and structurally short of food supply. And this is not just one bad monsoon or poor rain. This is a structural problem.

We need to stop pretending that this is temporary supply-side inflation or temporary supply shortage. The heart of the problem is that demand has consistently out-stripped supply for a long time. The quicker we actually start believing that this is driven by structural shortages in the economy,the sooner we will start addressing the structural issues in agricultural services. And one of the highest spikes that we have seen in the last one year or longer was in services inflation in CPI. It is doctor fee and inflation fee that has risen considerably over the last one year. While there here has been a lot of talk about the spike in inflation being due to the cyclical shortages caused by the bad rains,that is only partially true. We should realise that there is a momentum in inflation that will keep it up for quite some time.

So,high growth rate will be accompanied by high inflation?

We will have to live with higher normal inflation than what we were used to over the last four-five years. And until and unless we really tackle the structural supply bottlenecks in agriculture as well as in industry and services,we are sort of entering into a phase where we will be in short supply structurally for quite some time. And we will,therefore,probably have to tackle a high level of inflation than what we are used to.

There is a general worry that food inflation is spilling over to sectors.

I don’t think it has ever spilled over to the other sectors. The other sector dynamics were always separated from the food inflation. If you have 16 per cent industrial production for about three months,capacity will get stretched,it is showing up in higher higher non-food inflation. It would have been a spill-over effect,if,let’s say,IIP (index for industrial production) numbers were 8 to 9 per cent and non-food inflation was going up. Yes,you are seeing IIP numbers growing by 16 per cent and in three to four months and you are bound to see capacity-building constraints trying to bind and therefore this will have some effect on the non-food inflation.

One of the big problems this time around is that we haven’t had any capacity addition in the last 12 to 15 months. Corporate investments have languished in the last year or so. Firms haven’t invested in the last 12-15 months because of the global crisis. There was no addition to capacity and with IIP growing at 16 to 17 per cent,you are bound to have pressures on non-food inflation.

When will the inflation peak?

We expect headline inflation to peak around 12 per cent in June and then moderate to around 7-7.5 per cent by March-end next year. Food inflation will decline but non-food inflation will compensate for it by trying to pick up.

What is the outlook for the next financial year?

We will probably have a new medium-term average at 6 to 6.5 per cent rather than at 5 per cent. It will be important for the Reserve Bank and others to re-calibrate the monetary policy to higher normal because if they do not do that,they will be tightening way too much. Therefore,I think they need to calibrate the monetary policy with higher than normal.