The battle against inflation

The headline inflation, measured by the wholesale price index (WPI), moved up to 8.31 per cent in February from 8.23 per cent in January. Most analysts had expected some slowdown in headline inflation, as food price inflation has showed some moderation in recent weeks.

However, such expectations were belied as the latest inflation numbers seem driven by non-food inflation, which rose sharply to 6.1 per cent in February from 4.8 per cent in January. Moreover, the non-food inflation had accelerated across manufacturing activities.

Meanwhile, the Industries Department too has revised the annual rate of WPI-based inflation for December 2010 to 9.41 per cent, from the earlier provisional estimate of 8.43 per cent. This indicates that the latest readings too could be an underestimation of the underlying inflationary pressures and they could be revised upwards.

RBI's worry

The Reserve Bank of India has once again hiked its ‘repo' and ‘reverse repo' rates by 25 basis points each to 6.75 per cent and 5.75 per cent, respectively, with effect from March 17, while releasing its Mid-Quarter Monetary Policy Review. With this, the central bank has hiked its short-term rates eight times since March 2010.

Thus, the repo rate has risen by 175 basis points and the reverse repo rate by 225 basis points over the past year. However, one cannot escape the feeling that the country's central bank has been fighting a losing battle against inflation that has become stubborn.

Unfortunately, the monetary policy of the central bank and the fiscal profligacy of the Centre seem to be working at cross purposes, rendering the monetary tightening ineffective. The monetary policy can, at best, limitedly rein in inflationary pressures that largely emanate from the supply-side bottlenecks and high fiscal deficit.

In fact, the RBI has asserted that fiscal consolidation remains a key priority in inflation management and inducement of higher growth. It points out that underlying inflationary pressures have accentuated even as risks to growth are emerging. “As domestic fuel prices are yet to adjust fully to global prices, risks to inflation remain clearly on the upside, reinforced by the persistence of demand-side pressures,” the RBI adds.

The RBI has raised its inflation projection to 8 per cent for March this year, from the earlier projection of 7 per cent made in January, which is an increase of 2.5 percentage points.

OFFICIAL APATHY

The continued official apathy towards fiscal consolidation and resolving supply-side issues is largely contributing to the persisting inflationary pressures. In the prevailing situation, the RBI can only go through the motions of hiking policy rates periodically to send signals to policymakers about its growing concern over inflationary pressures.

What is rather shocking is that policymakers have been routinely making statements that inflation will come down soon, but have consistently missed their projections.

Even now the Government's Chief Economic Advisor, Mr Kaushik Basu, has stated that he expected inflation to fall to 7.5 per cent by end-March and sharply below 7 per cent in April. From the frequent assertions by policymakers that the inflation rate would soon fall, one suspects they are perhaps clueless about the nature of inflation and ways to deal with it.

They would be better off not making predictions about falling inflation and offering flimsy excuses when they go wrong.

Question mark over GDP

Incidentally, the latest budgetary projection of fiscal deficit falling to 4.6 per cent of the GDP in 2011-12, from 5.1 per cent in 2010-11, is based on the assumption that the GDP growth during the year would be around 9 per cent. However, some recent developments have put a question mark over this assumption.

The GDP numbers for the December 2010 quarter of 2010-11 at 8.2 per cent signal a significant slowing of growth from the 8.9 per cent notched up in the first two quarters. The growth in manufacturing fell to 5.6 per cent during the third quarter. Moreover, the recent weak performance of the capital goods sector in the IIP suggests that the investment momentum could be slowing.

The RBI has already warned about the fragile investment conditions.

“Continuing uncertainty about energy and commodity prices may vitiate the investment climate, posing a threat to the current growth trajectory,” it said. With global oil prices threatening to remain elevated, fuel has now replaced food as India's key inflation worry.

The global financial services firm Morgan Stanley has already lowered its economic growth forecast for India's GDP to 7.7 per cent in 2011-12, its second cut since January. It says that the domestic demand growth is expected to be slower than its earlier estimates. The rate hikes by the RBI will only add to this sentiment.