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No relief from inflation

Indicus Analytics
Published: 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 some


are singing praises for an RBI that is more sensitive to industry needs, others
are lamenting its lack of action to address India’s 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 since
April 2008 that is we have had two years of above average and extremely
high consumer price inflation already. Second, with growth on a stronger
footing, companies are getting their pricing power back - price rises in food,
commodity and energy have now been making their way into the
manufactured product space.

Consumer price inflation for rural areas (CPI-AL) stands at 15.77% in


March and for urban industrial workers (CPI-IW) was at 14.86%. Consumer
inflation will come off its highs, though very gradually and will continue to
rule in the 8-10% range in the year ahead. Meanwhile inflation in wholesale
prices (WPI) is touching 10 percent currently. It will move down towards
5.5% levels only by the third quarter (October- December) of this year; but
this will largely be the base effect working, and month on month rises will
continue 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 government’s prediction is right, and food
price inflation falls, manufactured items and energy prices are going to rise
over the next few months.

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

But if the new RBI continues to go soft on interest rates and puts in
moderate rises of 25-50 basis points at each review this year, the ball is back
in the government’s court. What will the government do? No more energy
price increases, its ability to increase minimum support prices will also be
compromised, 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 a
record low in a whole decade? The reason is quite clear to all and as it says
from its own review – it has decided that its hands are tied. The
government’s borrowings programme needs to be accommodated by the
RBI, sufficient liquidity needs to be provided, yields cannot be allowed to
rise too high. We have consistently maintained that loose purse strings, with
no effort to raise efficiency in distribution systems, will only result in
inflationary pressures mounting in the system. With political expediency
being the order of the day, we can expect little in the way of significant
reform in the way the government operates.

The new RBI will do the bare minimum of what it is expected to on the
inflation 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

12.0 14.0%

10.0 12.0%

10.0%
8.0
8.0%
6.0
6.0%
4.0
4.0%
2.0 2.0%

0.0 0.0%
2000-01 2001-02 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10 2010-11*
M inistry of Finance estimates of
growth in 2010-11and 2011-12; Growth CPI IW inflation
*Forecasted

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

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