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No relief from inflation

Indicus AnalyticsPublished: ET

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WPI inf lation Repo

The RBI, the Interest rates, and Inflation

RBI is showing a surprising reluctance to increase interest rates; while someare singing praises for an RBI that is more sensitive to industry needs, othersare lamenting its lack of action to address Indias inflation problem.

And there is a serious inflation problem, which is not going away soon.First, consumer price inflation has consistently been above 7% levels sinceApril 2008 that is we have had two years of above average and extremelyhigh consumer price inflation already. Second, with growth on a strongerfooting, companies are getting their pricing power back - price rises in food,

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commodity and energy have now been making their way into themanufactured product space.

Consumer price inflation for rural areas (CPI-AL) stands at 15.77% inMarch and for urban industrial workers (CPI-IW) was at 14.86%. Consumerinflation will come off its highs, though very gradually and will continue torule in the 8-10% range in the year ahead. Meanwhile inflation in wholesale

prices (WPI) is touching 10 percent currently. It will move down towards5.5% levels only by the third quarter (October- December) of this year; butthis will largely be the base effect working, and month on month rises willcontinue throughout the year.

The government feels that food price inflation will fall dramatically by itself.Perhaps that is why it is holding more than double the amount of food stocks

than what is required. Even if the governments prediction is right, and foodprice inflation falls, manufactured items and energy prices are going to riseover the next few months.

The March HSBC Markit PMI showed input prices had reached their seriesrecord high i.e since 2005 and in April, input and output price indices rosehigher again. Global prices are creeping upward. Higher crude prices(already touching $86), iron ore, coal, steel (the average global price of steelis up 12% in April month on month), rubber (prices expected to rise 35% inthe second half of the year) - all these are going to seep into the domesticmarkets. Further economic growth is unhindered and is bound to putupward pressure on commodity and asset prices.

But if the new RBI continues to go soft on interest rates and puts inmoderate rises of 25-50 basis points at each review this year, the ball is backin the governments court. What will the government do? No more energy

price increases, its ability to increase minimum support prices will also becompromised, and it may need to control expenditure growth in its welfare

programs.

So while the RBI recognises the pressures in the system, why are rates still arecord low in a whole decade? The reason is quite clear to all and as it saysfrom its own review it has decided that its hands are tied. Thegovernments borrowings programme needs to be accommodated by theRBI, sufficient liquidity needs to be provided, yields cannot be allowed torise too high. We have consistently maintained that loose purse strings, with

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no effort to raise efficiency in distribution systems, will only result ininflationary pressures mounting in the system. With political expediency

being the order of the day, we can expect little in the way of significantreform in the way the government operates.

The new RBI will do the bare minimum of what it is expected to on theinflation front. But there has been little help from the government till now -the fiscal roadmap reducing the deficit over the next few years will not be

sufficient. The damage has been done. A long hot and sweaty summer lies

ahead.

Contact Sumita Kale (sumita@indicus.net) for comments.

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Growth CPI IW inflation

Ministry of F inance estimates of

growth in 2010-11and 2011-12;

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