Mumbai: Royal Bank of Scotland (RBS) said inflation will be the biggest headwind for the economy in 2011 as increasing income, coupled with more government spending and rising crude prices, will keep pressure on the price front, neutralizing RBI’s efforts to contain it.
Stating that the recent dip in headline inflation numbers should not be equated to a decline in the actual price levels, a RBS report said this dip is due to base effects and therefore, largely illusionary.
“November inflation data clearly showed this as on an annual basis inflation eased to 7.48% from a cyclical peak of 11% but accelerated 7% on a monthly basis, while the rise in core inflation was even more visible at 10.2%,” RBS Asia strategist Sanjay Mathur said in the report on Monday.
Though both headline inflation and food price numbers have been heading south since the recent months, soaring prices of some food articles like onions, tomatoes and garlic pushed food inflation to a 10-week high of 14.44% for 18 December -- an upward march for the fifth week in row. But this is still lower from the 21.29% a year ago. The recent Rs3 hike in petrol price also impacted the inflation.
Mathur admitted that costly food items were the major reasons for the rapid rise in inflation in the recent weeks and said this showed the structural divergence between rapid income growth and stagnant farm productivity. He further said over the past month, price rises were seen across several sectors like auto, FMCG and transportation.
“Rising input costs were the main trigger but treating this as a supply side issue is fallacious. The point is that strong demand has allowed firms to pass on rising costs and it is unlikely to get better. Surveys are showing expectations for higher selling prices are hardening,” Mathur said.
Pointing out that higher public spending will give only short term reprieve to liquidity, Mathur said, this will further complicate inflation management. The government’s cash balance with RBI rose to a high of Rs1 lakh crore in mid-December, a figure that is very close to the average net liquidity crunch in the system.
But government spending is not a durable solution in the face of rising inflation. Firstly, this build-up in government cash balances is an anomaly caused by 3G haul. Secondly, the government surpluses are a form of sterilization. Hence, a shift would amount to de-sterilization and accelerate the pace of monetary expansion, which would further fuel inflation, Mathur said.