Inflation, Iraq pose fresh challenge to Modi govt

Rupee breaches 60 per dollar level; finance minister says govt tracking currency’s movement closely

In May, WPI rose 6.01% as increase in potato prices pushed up food inflation to 9.50% from 8.64% in April. CPI had fallen in May. Photo: Indranil Bhoumik/Mint
In May, WPI rose 6.01% as increase in potato prices pushed up food inflation to 9.50% from 8.64% in April. CPI had fallen in May. Photo: Indranil Bhoumik/Mint

New Delhi: Wholesale price inflation accelerated in May at the quickest pace since December, led by an increase in food and fuel prices, unnerving investors heartened by a raft of encouraging macroeconomic indicators last week.

A sharp escalation in internal strife in Iraq, which could cause crude oil prices to rise further, and expectations of a below-normal monsoon have also injected a renewed sense of uncertainty in the economy.

To be sure, it is too early to posit that the rebound in Wholesale Price Index-based ((WPI-based) inflation and the strife in Iraq, India’s second largest oil supplier, are setbacks sufficient to reverse the recent turnaround in sentiment.

Still, on Monday, the S&P BSE Sensex edged down 0.15% to 25,190.48 points at the close of trading on the Bombay Stock Exchange and the rupee once again breached the 60 per dollar level to end at 60.17, the lowest level since 6 May.

WPI-based inflation rose to 6.01% in May from a provisional 5.2% a month ago, as food inflation quickened to 9.5% from 8.64% a month ago, while fuel prices were up by 10.53% compared with 8.93% in the previous month.

In food inflation, the prices of potatoes, fruits, protein-rich items such as egg, meat and fish rose while an increase in the price of petrol led to the jump in fuel inflation.

Core WPI inflation, or non-food non-fuel inflation, rose to 3.8% from 3.4%, largely due to higher prices of basic metals, wood and paper products.

The statistics department also revised the inflation number for March to 6% from the provisional figure of 5.7% released earlier.

Last week, investors had been encouraged by positive data that showed higher factory output, increased exports and softening consumer price inflation, which slowed to 8.28% in May from 8.59% in April as vegetable prices eased.

The divergence in the consumer price and wholesale price indices may baffle policy makers, although the Reserve Bank of India (RBI) has made it clear that in setting monetary policy, it will be guided by retail inflation trends.

Citigroup India economist Rohini Malkani said in a research note that while the focus has increasingly shifted towards Consumer Price Index-based (CPI-based) inflation, she believes trends in the WPI data are also important.

“In the near term, the upside risks to inflation not only come from monsoons, but also from the recent spike in crude on tensions in Iraq,” she said.

Rainfall in the June-to-September monsoon is expected to be below normal, with the threat of the El Niño weather phenomenon looming.

“The rise in prices of food articles can also be attributed to withholding of stocks on account of apprehension of a weak monsoon,” finance minister Arun Jaitley wrote in a post on Facebook. “The State Governments should take effective steps to ensure that speculative hoarding is discouraged. The Government is committed to take measures which will positively impact the GDP (gross domestic product) and result in higher growth than expected. I am hopeful that the inflation which is moving upwards now would eventually come down,” he said.

Jaitley also said the government was watching the movement of the rupee closely.

The impact of the escalating violence in Iraq spilled over to energy markets, triggering concerns over its oil exports. Brent crude, which surged above $114 on Friday for the first time in nine months, rose 0.7% to touch an intraday high of $113.28 on Monday, according to Bloomberg.

Malkani, however, said given the base effect turning favourable from June onwards and likely government measures to rein in food inflation, “we maintain our view of WPI trending down toward an average of 5.5% and CPI at 8% in FY15.”

President Pranab Mukherjee, in his speech to the joint session of Parliament earlier this month, said containing food inflation will be the top priority of the new government.

He said the government is alert to the risk of a sub-normal monsoon this year and is preparing contingency plans to address it.

The government has promised efforts to kick-start economic growth, which slumped to sub-5% levels in each of the previous two financial years.

On Saturday, Prime Minister Narendra Modi warned of “tough decisions” over the next couple of years to nurse the economy back to health, lamenting the precarious conditions his Bharatiya Janata Party-led (BJP-led) government had inherited from the United Progressive Alliance regime.

“Taking tough decisions and strong measures in the coming one or two years are needed to bring financial discipline, which will restore and boost the country’s self-confidence,” Modi said addressing BJP workers in Panaji.

Finance minister Arun Jaitley, who will present his maiden budget in the second week of July, has said that his focus will be on fiscal consolidation reviving the growth momentum and containing inflation.

The increase in the price of de-regulated fuel items and rise in global oil prices on account of geopolitical tensions may add an upside bias to inflation, said Yes Bank Ltd chief economist Shubhada Rao.

“While our base case scenario continues to be no change in policy rates in FY15, a strong action from the government if it helps to improve the growth-inflation mix in the economy will be viewed favourably by the RBI. This, in our opinion may create room for a possible cut in repo rate towards the end of FY15,” she said.

RBI kept key interest rates unchanged this month, but said it may ease monetary policy if inflation slows faster than anticipated. The central bank kept the repo rate, at which it lends short-term funds to banks, at 8%, having raised it by 75 basis points to tame rising prices since governor Raghuram Rajan took office in September. One basis point is one-hundredth of a percentage point.

RBI, however, lowered the proportion of deposits banks must invest in government bonds to 22.5% from 23% with effect from 14 June.

Frequent rate hikes aimed at squeezing demand and curbing inflation have hurt investment.

For the first time since 2000-01, the investment rate contracted by 0.1% in 2013-14.

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