May inflation at 10.16% puts rate pressure on RBI

An immediate hike in fuel prices looked unlikely on Monday, after data showed that inflation rose at an unexpected 10.16% in May. With the return of double-digit inflation coming on the top of last week?s news that April industrial output growth was at a 15-year high, policymakers indicated that the Reserve Bank could go for a moderate hike in key policy rates even before the quarterly review in July, but many analysts FE spoke to did not seem to agree with that forecast.

Rating agency Fitch on Monday raised its credit rating outlook on local currency debt to ?stable? from ?negative?, thanks to a one percentage-point difference that revenues from 3G spectrum auction could bring to the country?s fiscal deficit. The Fitch upgrade follows Standard & Poor?s raising India?s debt rating in March, on similar growth prospects.

Finance minister Pranab Mukherjee said double-digit inflation was a matter of concern.

?High inflation will continue till middle of July. After July, when the trend of monsoon will be well-known, inflationary pressure on food items will come down,? Mukherjee told reporters on the sidelines of a bankers? meet in Patna.

Finance secretary Ashok Chawla was quoted by Reuters as saying that the country might be able to cut its fiscal deficit to 4.5% of GDP in 2010-11 because of revenues from 3G auctions (about Rs 1 lakh crore) and robust economic growth. The budget estimate for fiscal deficit ? the amount by which spending exceeds non-borrowed receipts ? is 5.5%.

According to analysts, resurgent economic activity and the resultant pick-up in demand pushed up the wholesale price index (WPI), the headline inflation indicator, to 10.16% in May over the same month a year ago. In April, the rate of inflation was 9.59%.

Even though the spike in core inflation ― headline inflation exclusive of food and fuel prices ? triggered calls from policymakers for raising key rates, analysts expect the central bank to leave rates untouched until the monetary policy review scheduled for July 27 on account of tight liquidity scenario in the system.

Expressing concern over the May figures, Chawla said the government was in touch with the central bank regarding the measures which would be needed. ?Something more needs to be done by RBI, and they are doing it,? he said here.

With March figures getting revised upwards to 11.04%, analysts are not ruling out a similar scenario for May provisional figures also .?Some action would be called for by the RBI in terms of policy tightening… some action on the demand side,? said C Rangarajan, chairman of Prime Minister?s economic advisory council.

The central bank has already hiked key policy rates twice by 25 basis points each since mid-March. Because of the lag in monetary policy transmission, it is expected to have an impact on the ground only by November at the earliest.

Outflows due to the sale of 3G airwaves and broadband spectrum along with advance tax payments are expected to keep squeezing liquidity out of the system until the end of July. Till money starts flowing back from the second half of July, overnight lending rates are expected to remain in the upper end of the repo corridor.

Food inflation for May was at 16.5%, fuel inflation came in at 13.1% and manufacturing inflation ? a key measure for central bank policymakers ? was 6.4 %, slightly off April?s 6.7%. While hardening tendencies in food and fuel prices have plateaued out, the sudden spike in items like iron and steel contributed to the hardening of headline inflation.

?The core inflationary scenario looks sticky and the central bank must be keeping a close watch on it,? said the country?s chief statistician Pronab Sen, adding: ?Their headroom for manipulating the monetary levers without upsetting growth projections is still limited.? According to Sen, headline inflation could have peaked in May and with the base effect setting in, the numbers could ease to 5-6% levels by December. RBI expects headline inflation to be in the comfort zone of 5.5% by next March.

The 10-year bond yield rose 6 basis points to 7.67% after the data, while one-year indexed swap rates also rose 5 basis points.

RBI has so far maintained that normalisation of monetary policy will be done at a moderate pace in the light of the uncertainties posed to growth projections by the euro zone crisis. ?The central bank is behind the curve by choice, not by mistake,? said economist Suresh Tendulkar. According to him, RBI is looking at many factors before going for a hike in the policy rates as they cannot normalise the monetary policy regime only to reverse it immediately if the world economy enters another slowdown.

?India?s strong growth prospects and the one-off positive impact from telecom auctions underpin Fitch?s forecast that the government?s debt-to-gross domestic product ratio will decline,? Fitch said while affirming the nation?s long-term local and foreign-currency rating at BBB- , the lowest investment grade. S&P also maintained the nation?s long-term local and foreign-currency rating at BBB-, its lowest investment grade.