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Mr. Tim Callen and Dongkoo Chang

and WPI Inflation 2. Components of the WPI 3. Manufactured Inflation and the Output Gap 4. Actual and Fitted Values of the Equations 5. Out of Sample Forecast of Inflation References Appendix I. Data Definitions and Sources Appendix II. Details of Empirical Results Appendix Tables 1. Unit Root Tests 2. Johansen Maximum Likelihood Approach 3. Cointegration Using a Residuals Based Approach 4. Estimates of Output Gap Models 5. Estimates of Inflation Equations on Annual data 6a. Leading Indicators of Inflation: Bivariate Granger Causality

International Monetary Fund

/05 . Second quarter growth reached 6.6 percent, slowing from 7.1 percent the previous quarter, but slightly above staff’s projection. Industrial output rose by 7.9 percent year-on-year in November, slowing from 10.1 percent the previous month. 5. Inflation has moderated . WPI inflation has declined for five consecutive weeks, reflecting mainly lower prices of primary products and manufactured goods, and now stands at 5.8 percent, below staff’s projection for end-2004/05 of 6.4 percent. CPI inflation also declined in November, to 4.2 percent. 6. The trade deficit

Mr. Tim Callen and Dongkoo Chang

influences the manufacturing price index. Further, the mean of primary product inflation has exceeded that of the manufacturing inflation indicating that a focus on manufacturing inflation alone will likely underestimate “permanent” inflation. III. I nflation D uring the 1980 s and 1990 s WPI inflation was relatively stable between 1983 and 1990, averaging 6¾ percent, recording a low of 3 percent in early 1986, and a high of a little over 10 percent in early 1988 ( Chart 1 and Table 1 ). In the 1990s, inflation has, on average, been higher at 8¾ percent, and

International Monetary Fund. Asia and Pacific Dept

inflation that feeds quickly into wages and core inflation; entrenched inflation expectations; the pass through from a weaker rupee; and ongoing energy price increases. WPI inflation is forecast to remain above the Reserve Bank of India’s comfort zone, given that supply constraints will ease only gradually. The current account deficit should narrow in fiscal year 2013/14 to about 3.3 percent of GDP, supported by rebounding exports, higher remittances, rapidly-shrinking gold imports, weakening domestic demand, and broadly stable oil prices. The principal risk facing

Muneesh Kapur and Rakesh Mohan

-oil CAB/GDP WPI Inflation CPI Inflation REER Index @ Real Policy Rate # 2003-04 8.0 7.9 4.3 2.3 5.0 5.5 3.9 96.8 –0.4 2004-05 7.1 7.9 3.9 –0.3 2.8 6.5 3.8 99.9 –0.6 2005-06 9.5 9.3 4.0 –1.2 2.7 4.4 4.4 102.7 1.7 2006-07 9.6 9.3 3.3 –1.0 3.0 6.6 6.7 101.0 3.1 2007-08 9.3 9.8 2.5 –1.3 2.9 4.7 6.2 108.6 2.2 2008-09 6.7 3.9 6.0 –2.3 3.1 8.1 9.1 97.8 0.9 2009-10 8.6 8.5 6.5 –2.8 1.5 3.8 12.2 95.3 1

International Monetary Fund

, but this largely reflected the temporary seasonal impact of holidays. Strong momentum has also contributed to a widening trade deficit. WPI inflation edged up to 5.3 percent in November, mainly reflecting rising food and manufacturing prices. On the basis of recent data, staff has revised upward GDP growth to 8.9 percent for FY2006/07 and to 8.2 percent for FY2007/08, with upward revisions to the projected current account deficit (2 percent of GDP) and inflation (5.2 percent) in FY2006/07. 3. Fiscal revenues have been stronger than anticipated . The central