Inflation turns positive after 13 weeks, presents policy dilemma to central bank

According to the government data, India's inflation rate stood at 0.12 percent for the week ended September 5, higher than (-)0.12 percent reported in the previous week. Inflation rate stood at 12.42 percent during the corresponding week a year ago.

During the week under review, prices of food articles such as poultry chicken (up 16 percent), fruits & vegetables (up 8 percent), pork (up 5 percent), condiments & spices (up 3 percent), bajra (up 2 percent) and rice and moong (up 1 percent each) continued to surge.

Among food products, prices of sugar and sooji (rawa) (up 4 percent each), khandsari and bran (all kinds) (up 2 percent each) and maida, atta and gingelly oil (up 1 percent each) rocketed.

Among non-food items, raw silk, cotton seed and raw rubber (up 3 percent), polyester staple fibre (up 5 percent), lead ingots (up 4 percent), material handling equipment (up 6 percent) and electrical relays (up 3 percent) witnessed maximum increase in price.

The prices of bitumen (up 9 percent), furnace oil and light diesel oil (up 4 percent each) and aviation turbine fuel (up 2 percent) also rose.

The rise in inflation rate has sent jitters to market watchers as they feel that the surging food prices following the worst dry spell in nearly four decades will give the central bank a tough time in formulating monetary policies.

Reserve Bank of India (RBI) Governor D. Subbarao had cut interest rates six times from October 2008 to April 2009 to shield India's $1.2 trillion economy from the worst global recession since the Great Depression. However, in the last monetary policy announcement on July 28, he left the reverse- repurchase rate unchanged at 3.25 percent and kept the repurchase rate at 4.75 percent.

According to the analysts, India's inflation could climb above the comfort zone of policy makers and herald an end to a soft monetary stance. Earlier this month, the central bank had said inflation was becoming a concern sooner than expected, while the finance secretary forecast it to climb to 5-6 percent by end of March.

The rapid rise in the WPI could also pose a policy dilemma for the central bank given the inability of monetary policy to mitigate price pressures caused mainly by shortages in food supplies, they said.

"There are signs that the sharp decline in core inflation has been arrested and prices have started to inch higher," said Nomura economist Sonal Varma, adding that it might put pressure on the RBI to change its easy money policy as higher food prices will result in an increase in manufactured items.

"The momentum in the WPI inflation has been picking up since the last few months. Much of the increase in inflation is clearly indicative of input cost pressures picking up, and with demand set to recover we should see output prices also picking up with a lag. This will clearly mean that the RBI's concern on inflation is likely to continue and the exit from the current loose policy will depend on how soon growth picks up from here," the economist said.

"Input prices in manufacturing have started picking up. Manufacturers will pass on this price rise once competition and demand improves. So clearly, there is an upside risk to inflation. It could be both from the demand as well as the supply side," Varma said.

Agrees Rajeev Malik, economist at Macquarie Group Ltd. in Singapore. "Poor monsoon rains complicates the policy setting" for the Reserve Bank of India (RBI), Malik said. "The downside risk to growth warrants pro-growth measures, while higher inflation argues for policy tightening."

According to Rahul Bajoria, an economist with Barclays Capital, a weaker-than-expected monsoon will add to the inflationary pressures that "will continue to build in India in the coming months."

"A pick up in inflation is a serious concern," said Sherman Chan, an economist at Moody's Economy.com in Sydney. "The authorities are keen to make pre-emptive moves in containing inflation, though we expect the Reserve Bank to only tighten policy when growth returns above 7 percent."

According to D.K. Joshi, principal economist at CRISIL, the present inflation rate should not cause any concern to policy makers but it will give them sleepless nights in the last quarter of the present fiscal. "WPI has moved to positive zone quite quickly. Food inflation is not something which can be controlled by the RBI," Joshi said, adding that RB can do very little about price pressures caused by supply-side bottlenecks.

"What it (the data) is showing is that the pace of increase in prices is gathering momentum. Till now it is essentially food items and not too much implications for monetary policy. However, in coming weeks it is continuously going to inch upwards and by March-end it will definitely cross 6 percent. RBI will tighten only after there is a decisive upturn in the economy," he said.

Agrees Amol Agarwal, economist at IDBI Gilts. "Inflation is already positive again and the Reserve Bank of India faces a real tough task. The governor has said he wants to keep interest rates low till the economy recovers fully, but inflation is galloping and being responsible for inflation, it can't ignore it," he said.

While Gunjan Gulati, an economist at JP Morgan Chase, feels that "the fiscal measures - releasing the food stocks with the government, importing the foodgrains in short supply - will be the first mode of action likely to be adopted by the government, rather than monetary tightening to stem higher inflation," Nomura's Varma expects the RBI to withdraw excess liquidity in the fourth quarter of FY09 by hiking its cash reserve ratio CRR) when the bulk of the government borrowing is over.

The economist also expects the central bank to start hiking its repo and reverse repo rates from January by a cumulative of 125 basis points in 2010.

Likewise, HDFC Bank's chief economist Abheek Barua feels that the central bank will raise policy rates by 25 basis points in April next year and increase the CRR by 50 basis points by March.

Earlier this week, RBI governor said the central bank will not tighten its monetary policy unless an economic recovery takes hold, but it may have to exit the easy stance before other nations.

The latest inflation figures come close on the heels of the central bank describing the need to balance boosting growth against checking inflation as "a challenge" and Finance Minister Pranab Mukherjee expressing his doubts that the 6.1 percent pace of growth reported in the three months to June 30 will be maintained in the second and third quarters of FY10.