Central bank gripped by inflation concern

Central bank gripped by inflation concern

Mumbai: Concerns about persistently high inflation dominated a new report on the economy released by the Reserve Bank of India (RBI) on Monday, a day before it decides whether to increase interest rates or hold fire.

Governor D. Subbarao will decide at a time when strong economic growth has been accompanied by a raft of problems: high inflation, a large current account deficit, a strengthening rupee and fears of an asset bubble fuelled by cheap overseas money.

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Meanwhile, the US Federal Reserve is due to announce significant monetary easing this week as part of a second round of quantitative easing even as credit conditions continue to tighten in the Indian financial system because of weak deposit growth and strong credit growth.

The central bank said in its latest Macroeconomic and Monetary Developments that though inflation shows some “signs of peaking off", it continues to be “beyond the comfort level". Though inflation measured by wholesale prices has fallen from its April peak of 11.23% to 8.6% in September, it is still above RBI’s FY11 forecast of 6%.

“Inflation pressures persist and further moderation would be necessary for easing the concerns for the conduct of monetary policy," the central bank said.

Economists point out to the tough tone of the report. “It is quite hawkish on inflation. Relatively, statements on other issues are less in number and muted," said Indranil Pan, chief economist of Kotak Mahindra Bank Ltd.

The central bank also hinted that its gradual monetary tightening since October 2009 has started to pay off. It said that while food inflation “remains disconcertedly high despite a normal monsoon", inflation in non-food manufactured products, “which could be seen as most sensitive to monetary policy measures", has moderated.

RBI has raised its key rates five times since March. It has so far raised its repo rate, or the rate for injecting liquidity into the banking system, by 125 basis points and the reverse repo, or the rate at which it drains liquidity from the system, by 175 basis points. One basis point is one-hundredth of a percentage point.

“The tone is definitely hawkish. Even if the market was divided on rate hike prospects, going by the review statement, it looks like 25 basis points hikes in policy rates are in the offing," said Amol Agrawal, economist at STCI Primary Dealership Ltd.

Compared to the warning signs it has flashed on the inflation threat, RBI seemed far more sanguine about the immediate growth prospects of the Indian economy. The central bank said that factors such as the normal monsoon, strong industrial growth, the sharp rise in excise duty collections, strong growth in corporate sales, robust consumer demand and increase in demand for credit from the private sector suggest that the economy is on track to grow at 8.5% this fiscal.

New data released on Monday shows that the Indian economy continues to expand smartly. The HSBC India Manufacturing PMI (Purchasing Managers’ Index)—a lead indicator of economic activity—for October came in at 57.2, rising from the September level of 55.1. A reading above 50 shows economic expansion.

“After some bouncy data in the last few months, India’s economy has picked up steam once again," said Frederic Neumann, co-head of Asian Economics Research at HSBC. He also added that price pressures were a worry, “possibly prompting the central bank to hike (rates) again before the end of the year".

But the central bank added that growth would be heavily dependent on private consumption and investment demand, given the prospect of weak exports to a stuttering global economy and pressure on government demand because of the need to cut the fiscal deficit.

A survey of bankers and bond dealers by Mint over the weekend found that 10 out of 14 bankers, dealers and investors expect a 25 basis points hike in RBI’s two policy rates.

The Indian central bank also pointed out to the risks of a current account deficit that is at its highest since the economic crisis of 1991. “While the (current account) deficit may be fully financed by capital inflows, the potential volatility of such flows poses some risk," the RBI report warned.

“Presently, an important concern from the point of view of inflation management is the downward rigidity in the primary food articles prices even after a good monsoon," the report said, adding that it was expected that normal monsoon would moderate the food prices “substantially", which did not happen and food articles inflation continued to remain in double digits. Part of the reason for this, as RBI noted, is the change in consumption pattern due to rising income levels.

Food inflation was 13.75% for the week ended 16 October. It has remained in double digit for the past three months.

“...the consumption basket is getting diversified more in favour of non-cereal items such as milk, vegetables, fruits, meat, poultry and fish, which are important from the nutritional angle" and have contributed the most to the food price inflation, the report said.

The persistence of high food inflation “not only has adverse welfare effects as the poor have larger share of food in their consumption basket, but could also impact the core inflation after a lag, causing a generalization of price pressures", it added.

RBI’s concern on high food inflation has been equally shared by the Central government as well. Finance minister Pranab Mukherjee on Monday said that inflation is a matter of concern and prices are being stoked by food costs. Mukherjee had met Subbarao on 29 October in New Delhi to get a customary update of the economy before the monetary policy review.