Struggle against inflation continues

Written by Indranil Pan | Updated: Mar 18 2011, 08:00am hrs
The struggle to contain inflation while supporting growth continues for RBI. As was the case in January, the decision of RBI in this policy meeting also came on the backdrop of the headline WPI inflation surprising on the higher side.

While all had estimated the February inflation to come down, it actually increased to 8.31% from 8.23% in January.

Further, manufactured ex-food inflation rose to 6.09% in February from 4.8% in January, indicating strong demand side pressures in the economy. And further the number for December suffered an upside revision by around 100 basis points to 9.41%.

There was no doubt that RBI would maintain inflation containment as the key strategy of its monetary policy and in accordance would increase the policy interest rates.

The repo rate was thus raised by 25 basis points that now stands at 6.75%, while the reverse repo rate was raised by 25 basis points to 5.75%.

However, no suggestions from the working group on Operating Procedure of Monetary Policy were brought into implementation in this policy. This, we think would be implemented by RBI at the time of announcement of the Annual Policy in May 2011, when the operative rate would be one single rate.

Interestingly, the RBI feels that headline WPI inflation would end this fiscal at 8.0% from the previously anticipated 7.0%. It clearly indicates that the underlying inflationary pressures have accentuated and that the risks of inflation are clearly on the upside.

The other interesting point to note is that the word calibrated increases could not be found in the central banks press release.

Therefore the natural question: Is RBI leaving adequate room for a more aggressive stance in monetary policy in the near future Possibly yes, but we doubt if that would be RBIs immediate intention.

While maintaining its hawkish rhetoric on inflation, the Reserve Bank also points out to the risks of growth that are emerging, both out of the local factors and global issues, such as rising oil prices.

It points out that the weak performance of the capital goods sector in the IIP suggests that investment momentum in the economy could be slowing. It also points out that there could be further risks to the domestic investment momentum arising out of the continuing uncertainty about energy and commodity prices.

RBI expects some easing of demand-side pressures from the fiscal-side. However, it continued to remain critical of the fiscal situation and indicated that the demand-side adjustments on the fiscal side could only be achieved if commitments to contain subsidies are adhered to.

This could be difficult, as the government might continue to desist raising domestic fuel prices adequately to reduce the under-recovery gap in an already adverse inflation scenario. Thus, RBIs continued fight against inflation could fall short of its own expectation so far as bringing down the headline WPI inflation is concerned.

But to reiterate, we do not think that RBI would enhance the pace of monetary tightening as growth worries are likely to continue. As per current understanding, we would expect RBI to stop its tightening cycle when the repo rate reaches 7.25-7.50%.

The author is chief economist at Kotak Mahindra Bank. The views expressed in this article are his personal