Oil price casts cloud on inflation

RBI REPORT ON CURRENCY & FINANCE: 2002-03

Reserve Bank of India (RBI) said the downward bias in inflation rate may not be attainable due to the uncertain outlook for oil prices in the near-term and an increase in world commodity prices.

It observed that these international developments enhanced the probability of transmission of inflation from abroad to India.

The central bank, however, maintained that the inflation range of 4-4.50 per cent, which was indicated in the mid-term review of the monetary and credit policy in November 2003, continues to be relevant for policy purposes unless there are unanticipated severe shocks.

Analysts, however, feel that the year-end inflation could veer around 5.50 per cent.

"The inflation trends in the last two months have not been unexpected but the magnitude of price rise has been above expectations. This increase in inflation appears to be mainly on account of mineral oil, cotton textiles and oil seeds," the RBI said in its "Report on Currency and Finance-2002-03".

The annual rate of inflation was at 6.7 per cent in April 2003 when the policy projections were made. It continued in the range of 6.3-6.9 per cent till May 2003.

It, however, declined to around four per cent in August, before climbing back to five per cent or more since September 20, 2003. Inflation has since risen further since the mid-term review and for the week ending January 10, 2004, it touched a 39-week high of 6.21 per cent.

Two international factors have contributed to the more-than-unanticipated upward pressure on prices.

First, international oil prices have remained firm. The average price of the Organisation of Petroleum Exporting Countries basket had reached $29.5 a barrel at the end of 2003, while US prices were hovering around $ 32 a barrel.

Global oil prices were, thus, at around 10 per cent higher than they were at the time of the mid-term policy review. Second, world primary commodity prices have also increased in 2003.

These trends, along with a revival in growth and falling excess capacities in several advanced economies, have brought about a noticeable shift in the outlook for prices.

The fear of deflation in advanced economies has been replaced by a possible upward pressure, led by increases in commodity prices.

The central bank said there are three favourable factors to counter these recent adverse global developments.

First, in the normal course, it is expected that the inflation rate would fall between mid-January to March 2004. Second, there are cushions in terms of food stocks and ample forex reserves.

Third, the Indian economy has, in recent years, shown remarkable resilience in absorbing shocks.

Monetary experience, according to the RBI, suggests that sustained excessive monetary expansion has often spilled over into inflation.

While the increase in foreign exchange reserves reflects the growing investor confidence in the Indian economy and provides an insurance cover against adverse external shocks, there is also the need to mitigate the inflationary potential by counterbalancing the domestic and external sources of monetisation.