Inflation rises ahead of policy review

Inflation rises ahead of policy review

New Delhi: India’s headline inflation as represented by the Wholesale Price Index (WPI) unexpectedly accelerated to 8.31% in February from 8.23% in the previous month, ahead of the key mid-quarter monetary policy review, when the central bank may be forced to hike key policy rates to cool down inflationary expectations.

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Analysts were expecting annual inflation rate to come down below 8% in February.

While food inflation has so far been the key driver of the WPI inflation, new price pressures emerged in February from manufacturing and fuel groups, which rose by 4.91% and 11.49%, respectively.

The nearly one percentage point revision in annual inflation rate for December to 9.41% from the provisional estimate of 8.43% also showed higher price pressures than anticipated.

Core inflation, or non-food manufacturing goods inflation, which the Reserve Bank of India (RBI) is more concerned about, rose to 6.1% in February from 4.8% in the previous month. The manufacturing group saw across-the-board hardening in prices such as in beverages, machinery and chemicals. RBI had earlier warned of higher food price inflation spilling over to manufactured items.

Finance minister Pranab Mukherjee expressed hope that inflation will come down to 7% by next month. “By March-end, it would be possible to have around 7-7.5% (inflation)," Mukherjee said.

However, analysts expect the new price dynamics may force RBI to go for another round of policy rate hikes as the central bank’s projection of 7% inflation by March end is unlikely to be met.

Nomura Financial Advisory and Securities (India) Pvt. Ltd economists Sonal Verma and Ketaki Sharma said in a report that the balancing act for RBI will get tougher due to significant tightening already in place and the weakness in headline industrial output numbers. “However, in the final analysis, we see RBI tightening by another 25 basis points both the repo and the reverse repo at its 17 March meeting, with a further 50 basis points of hikes through the rest of the (calendar) year," they said.

Other economists also echoed this, anticipating a rate hike. Deepali Bhargava, economist at ING Vysya Bank Ltd, said in a research note that inflation numbers quite clearly are very high for RBI’s comfort. “The higher-than-expected inflation signifies a stronger spillover from food and fuel inflation to manufacturing inflation. The worsening of the global oil price situation will require RBI to contain rising inflationary expectations," she said.

Deutsche Bank economists Taimur Baig and Kaushik Das said given the trend in WPI, a 50 basis points rate hike by RBI at this week’s monetary policy announcement would be justified. “There is also considerable pipeline pressure, with petrol and diesel prices likely to be hiked in mid-2011," they added.

Even as crude oil prices have come down within a week to $99 (Rs4,475 today) per barrel, continued unrest in West Asia is expected to keep them at a higher level even though lower demand from quake- and tsunami-hit Japan is expected to ease demand pressure.

RBI has increased key policy rates seven times so far this fiscal. While the repo rate has been increased from 5% to 6.5%, the reverse repo rate has risen from 3.5% to 5.5%. Repo rate is the rate at which RBI injects liquidity into the banking system, and reverse repo rate is the rate at which it drains out the liquidity.

RBI is struggling to keep a balance between growth and inflation expectations at a time when growth in factory output is also declining. However, the January reading of industrial production suggests that industrial activity is not decelerating sharply. The Index of Industrial Production rose 3.7% in January from 2.5% in the previous month, higher than market expectations.

However, the Organisation for Economic Cooperation and Development (OECD) composite leading indicators for January released on Monday showed India’s growth outlook to “slowdown", with the index for the country contracting 2.2 points compared with the same period a year ago. OECD releases data for 33 member countries and six non-member countries.

RBI governor D. Subbarao had said on Thursday that it was a struggle to control inflation while supporting growth. “We are struggling with growth-inflation dynamics. For inflation management, we have to raise policy rates. For protecting, promoting and preserving recovery, we need to keep rates low. So there is tension between raising interest rates and keeping them low," he said.

RBI has projected an 8.5% growth rate for the Indian economy in the fiscal ending March.

Successive hikes in RBI’s key rates have led to most banks increasing their base rates, or the lending rate below which they are not allowed to lend, at least twice in the last two months. For instance, the country’s largest lender, State Bank of India, has raised its base rate to 8.25% through two hikes since January. Most other banks, including private sector ones such as ICICI Bank Ltd and HDFC Bank Ltd, have also hiked loan rates since the January policy.

Analysts believe higher price pressure will remain a policy irritant in 2011 as well. Nomura economists Verma and Sharma said even as base effects are positive, the outlook for underlying inflation is negative. “Higher raw material costs were partly reflected in higher core inflation this month, but we do not think the pass-through is complete," they added.

ING Vysya’s Bhargava also expects inflation in March at over 8%, implying a breach of RBI’s target of 7%. “Our estimates for 2011-12 reveal a scenario of an average inflation of 7.8% with oil price and food price shock providing the key upside risks," she said.

The Nomura economists also said there is typically a lag of about three months between a rise in global commodity prices and it being reflected in WPI inflation of manufactured goods. “Given the sustained uptrend in global commodity prices, notwithstanding the dip over the last week, manufactured (goods) price pressures are likely to remain high," the added.

PTI contributed to this story