New Delhi/Panipat, Jan. 12: Inflation raised its hydra-head once again today as it peaked at 5.58 per cent — surging past the upper limit of a Reserve Bank of India projection for the financial year 2006-07.
Finance minister P. Chidambaram tried to soothe fears of an immediate policy response to put the rogue genie back in the bottle.
“Inflation is a concern. It is triggered by supply side constraints mainly wheat, sugar and pulses. Sugar prices have stabilised. Wheat prices are still sticky and will stabilise when the new crop comes in,” he told reporters in Panipat on the sidelines of a function to mark the doubling of the capacity of IOC’s refinery.
“We continue to monitor inflation and continue to take all possible steps — be it on the monetary or fiscal side,” the finance minister said.
Eye on policy move
It’s the policy response that India Inc is really spooked about as it could trip up their dream run this year. Data put out by the Central Statistical Organisation (CSO) showed that industrial production had surged to an 11-year high of 14.4 per cent in November — the highest level since September 1995 — on the back of a strong manufacturing growth at 15.7 per cent with robust performance by the mining and electricity generation industries.
The Reserve Bank had vowed to keep inflation within a band of 5 to 5.5 per cent for the year ended March 31 and had flagged it as a major concern after the first policy review on July 26 last year. After a relatively good monsoon and inflation moderately under control, RBI governor Yaga Venugopal Reddy voiced concerns about an “overheating economy” in the second review on October 31 and decided not to raise rates.
With the third review looming on January 31, inflation is back on centre-stage and industry will be hoping Reddy doesn’t tweak interest rates — taking a cue from the Bank of England which stunned the Eurozone yesterday with an inflation-busting quarter percentage point rate hike — and scupper growth.
Interestingly, the government’s revised estimates normally turn out to be higher than the provisional figures released earlier. For instance, the revised estimates of inflation have already touched 5.61 per cent during the week ended October 21.
In a dilemma
The Reserve Bank now faces a clear dilemma: should it pump money into the financial system so that banks can shovel credit to fund infrastructure development as the government wants, or should it nudge up rates and ensure a soft landing for the economy'
Ironically, the cabinet yesterday gave the RBI the flexibility to fix statutory liquidity ratio below the present floor of 25 per cent so that banks could give more credit. But with inflation crossing the 5.5 per cent mark, the central bank has a stark choice: attack inflation, or provide more cash to the banking system.
Interestingly, Chidambaram said today the liquidity situation was more or less comfortable, but demand was very high.
North Block economists said they would “back the RBI in any move to raise rates”.
The RBI has raised the reverse repo — the key rate signalling device for the banking system — twice this fiscal: a surprise 25 basis point hike in June and another 25 basis point uptick in July. The reverse repo now stands at 6 per cent. Top officials said an increase in the bank rate — which is little used today as a rate signaller and currently stands at 6 per cent also — cannot be ruled out.
In October, the RBI chose to raise the repo rate (the overnight lending rate between banks) by a quarter percentage point to 7.25 per cent. It followed that up on December 8 by raising the cash reserve ratio — or the amount of money banks have to compulsorily keep with the central bank — by half a percentage point to 5.5 per cent.
Although Chidambaram has blamed supply side constraints for rising inflation, officials believe the huge increase in credit and money supply is equally to blame.
“Credit expansion has been very fast. Money supply growth has been a whopping 20.2 per cent. I am not saying we have overheated the economy but, yes, there are concerns,” cautioned the official with the department of economic affairs.
“Huge forex inflows have also not helped matters. While we may be exulting about the $9-billion foreign direct investment and $23 billion NRI remittance inflows, these have added to the money supply pressure within the domestic economy,” officials said.
They said new policies would have to be devised that would help the “export of capital out of India so as to maintain an equilibrium in the Indian markets.”