ALL EYES ON HIM: Y.V. Reddy, Governor, RBI (Pic by Tribhuwan Sharma)

The sharp rise in inflation cannot be linked to the base effect as it was at a high of 6.56 per cent on a year-on-year basis even in March 2007. Lehman Brothers’ (India) economist Sonal Varma says that rising global commodity prices — food, energy and metals — have put upward pressure on domestic prices. While the price pressure has been relentless across-the-board, it’s the sharp escalation in manufactured products’ prices in recent weeks that has caused this significant up-tick.

The contribution of basic metal prices to total inflation increased to 22.2 per cent for the week ending 15 March from 5.8 per cent in early 2008, thereby driving the overall increased contribution from manufactured products. “But if we exclude basic metals, then the contribution from manufactured products actually fell to 30 per cent from 53.4 per cent in the same period,” says Varma. Union Commerce Secretary G.K. Pillai has made it clear to iron ore miners to come up with a solution to knock down steel prices. “We won't wait for even a month,” he told reporters in New Delhi this week when asked for a timeframe. Other categories that have contributed to higher inflation are edible oils, pulses and processed food. The contribution of primary articles (including food) increased from to 26.1 per cent from 21.8 per cent in early 2008.

Yes Bank’s Chief Economist Shubhada Rao feels that the speed and intensity with which the headline numbers have scaled up has prompted significant reworking on inflation forecasts for the coming months. “The past two weeks (ending 15 March) have printed ugly inflation numbers with the wholesale price index (WPI) moving up by 1.64 per cent,” says Rao.

“What a difference three months can make,” says HSBC’s economist Robert-Prior Wandesforde. “In November last year, WPI was running close to 3 per cent, well below the central bank’s 4-4.5 per cent target. Although not (yet) at a level likely to be triggering panic within policy circles, the pace of increase must be of concern. In our view, a further sharp rise looks probable.” HSBC has revised its WPI forecasts upwards to show a 6.2 per cent average rate for 2008-09, and a peak of 6.5 per cent at end-2008.

Yes, the Centre has a problem on its hands. On 31 March, the Cabinet Committee on Prices, chaired by Prime Minister Manmohan Singh, announced a slew of measures to curtail inflation. It cut the import duty on refined oil (sunflower, soya bean, coconut and groundnut) and on hydrogenated vegetable fats to 7.5 per cent (from 20 per cent), on butter and ghee to 30 per cent (from 40 per cent), and on maize to nil (from 15 per cent) for an upper limit of 500,000 metric tonnes. Additionally, it also imposed an across-the-board ban on the export of non-Basmati rice, raised the ceiling on the minimum export price on Basmati exports to $1,200 from $1,000, and extended the ban on export of pulses by a year.

Will the measures on edible oils work? “China and India are the two biggest importers of vegetable oil, together accounting for 30 per cent imports of major edible oils. India is expected to import 15 per cent of both soy and palm oil,” says Standard Chartered Bank’s senior economist for India, Shuchita Mehta. “Given the recent rally in edible oil prices and that prices would remain on elevated levels going forward, the heat doesn’t seem to be going off.”

“Monetary tightening will increase the cost of capital,” says Religare Securities President (Equity) Amitabh Chakraborty. “Foreigners bought for three reasons — pro-investment policy, lower inflation, and high GDP growth. Suddenly, all three premises look uncertain.”

The RBI’s next review of monetary policy is on 29 April. So, what can be expected at the review? The governor gave a few cues. “Any decision has to be taken carefully as the situation is extremely complicated,” Reddy said. “There were many instruments available to contain liquidity, and we will not hesitate to use those instruments.”

But there is a fundamental question. Is the current rise in inflation a monetary or a supply-side issue? If it is the latter, how are monetary measures going to curb inflation? Lehman Brothers’ Varma is categorical that the rise in inflation is largely a supply-side issue. “While increasing productivity in agriculture remains a long-term strategy, there are supply constraints in the metal sector as well,” she says.

Varma is of the view that the RBI will aim to anchor inflationary expectations using the CRR, market stabilisation scheme (MSS) and the liquidity adjustment facility as tools to keep liquidity tight; and that there might not be a repo rate hike as it does not tackle supply-side issues and can slow growth further.

Rao feels that the RBI may allow the rupee to appreciate to limit the damage of easy liquidity feeding into price pressures. “We expect a combination of MSS and a possible CRR hike as the preferred first option by the RBI, with repo rate hike as the last resort,” he says. The outstanding amount under MSS now stands at Rs 1,70,000 crore, leaving a headroom of about Rs 80,000 crore.

The MSS helps RBI suck out the rupee liquidity that comes when it buys dollars from banks. It, therefore, auctions Treasury-bills and government securities, which are subscribed to by the banks. The MSS ceiling — now pegged at Rs 2,50,000 crore — is set in consultation with the Ministry of Finance.

It is also likely that the Centre may defer large expenditure and maintain higher cash balances with the RBI in April and May. Prior-Wandesforde is of the view that the Centre, which had shown its hand in the 2008 Budget targeted at the rural poor, will presumably await the verdict of opinion polls and local elections before deciding when to hold the general election; and if further measures are required.

The country waits with bated breath.

This email address is being protected from spam bots, you need Javascript enabled to view it

(Businessworld issue 8 - 14 April 2008)