Inflation as measured by the consumer price index for industrial workers has been in double digits since July 2009. It peaked in January at 16%, before declining to 13% in April. It is likely that the inflation in May and June will also be close to or a trifle higher than the 13% level of April. Wholesale prices available till May 2010 indicate that inflation in prices of all the major groups?primary articles, fuels and manufactured products?accelerated in May 2010 compared to April.

The sustained increase in inflation has raised arguments in favour of RBI hiking interest rates. The strongest argument in favour of RBI hiking interest rates is the rise in inflation in manufactured products. Inflation in prices of manufactured products was over 7% during January-March 2010. It declined to 6.7% in April and then to 6.4% in May. These rates are considered high and they reflect excess demand in the system. A hike in interest rates is one way of reining in demand. While there is some hope of the inflation in primary articles declining in response to a good monsoon and consequently a good crop this kharif season, there is no similar hope for manufactured goods. Inflation in manufactured products is driven on the one hand by domestic demand and, on the other, by global trends.

Domestic demand-driven inflation is best seen in the announcements by car and two-wheeler manufacturers raising their prices. This has been a frequent phenomenon and can be considered a good reflector of the trend in prices of other consumer durables. Inflation in machinery, in general, can be expected to be rising because of the boom in investments. Inflation in these items is driven by domestic demand. Separately, global trends in prices of commodities is leading to an increase in inflation in steel and other metals. These are also responsible for the rise in inflation in the textiles group.

However, within manufactured goods, inflation is higher in textiles and metals than in transport equipment and machinery items. In May 2010, inflation in wholesale prices of basic metals was 12% and that in textiles was 15% while in transport equipment it was less than 2%. In machinery it was less than 4%.

Thus, the overall inflation measure is driven more by global trends than by domestic demand increases. This makes inflation control through monetary interventions particularly difficult. A hike in interest rates can (at a stretch) reduce the demand for steel, but it cannot reduce the price of steel, if it is determined by global trends.

One reason why inflation has been high in the recent past is the extraordinarily sharp increase in imputed housing rent. Housing rent accounts for a substantial 15% of the weight in the consumer price index for industrial workers. In March 2010, inflation in housing was a whopping 33%. This is unrealistic on two counts.

First, households do not spend 15% of their budgets on rent. Most Indians live in their own houses and do not spend anything on rent. According to Consumer Pyramids, CMIE?s survey of households, only 12.5% of urban households pay rent and only 2.7% of rural households pay rent. Rent accounts for only a little over 1% of the total budget of all urban households and only 0.06% of all rural households. It accounts for only 0.5% for all households. Thus, the 15% weight assigned to rent is unrealistic.

Second, housing rent has not increased by 33% over the past one year. This unusual increase is the result of ?a revision of imputed rent for rent-free accommodation, reflecting the impact of the Sixth Pay Commission award on CPI inflation? according to RBI.

A hike in interest rates by RBI will not be able to make any correction to this ?imputed rent for rent-free accommodation?. On a y-o-y basis, the impact of this should get diluted substantially in July 2010 and then again in January 2011. Thus, independent of what RBI may do, inflation will decline a bit in July 2010 (we estimate by about 2-3 percentage points because of rent) and then again in January 2011. The kharif crop will further help reduce inflation, independent of RBI?s actions.

A hike in interest rates may be in order so as to arrest a possible increase in leveraged spending. But, RBI?s data available till February 2010 do not indicate any unusual increase in personal loans. Y-o-y, these were up by only 4.7%. Credit card and consumer durable loans outstanding had declined over the year and the highest increase was in educational and housing loans. This trend is quite agreeable with a conservative stand on lending and ensuring that easy money is not fuelling inflation.

The only, albeit poor, case for a hike in interest rates would be to signal to the financial markets that RBI is seriously concerned about inflation and is taking necessary steps to rein it in, although it really cannot do much about it without hurting growth itself. And, nobody wants to hurt growth now.

So, move on with a little tokenism.

The author heads the Centre for Monitoring Indian Economy