Sticky core inflation and possibility of QE3, may force RBI to slow down economy further.
The Reserve Bank of India (RBI)'s governor D Subbarao has his task cut out for him. Growth may have slowed down, but inflation clearly has not. Headline inflation for August (wholesale price inflation) has touched a 13-month high at 9.8 per cent year-on-year. This figure is higher than the expectations of most economists. And from the look of it, experts could not quite predict which way inflation would go, as forecasts of monthly WPI inflation typically hover within a narrow range. For August, they were relatively scattered, ranging from 9.2 per cent to 10.0 per cent. So, the outcome was closer to the high end of expectations, says Barclays Capital’s India economist, Siddhartha Sanyal.
From textiles to base metals to food, prices of everything are up. Manufacturing inflation contributed 460 basis points to the overall headline number. Food inflation continues to be in the double digit region, just as non-food manufacturing inflation remains above 7.5 per cent. Primary food inflation rose to 9.6 per cent year-on-year (compared to 8.2 per cent in July), with strong increases for rice, vegetables, potatoes, onions, and fruit, says HSBC’s Leif Lybecker Eskesen, Chief Economist for India and ASEAN.
The stickiness of the non-food core inflation suggests that pricing power has not been completely demolished. While fuel contributed 200 basis points to the headline print, it’s apparent that non-food manufacturing inflation is the main culprit. And to combat this, the RBI will most probably opt for another rate hike, before the cycle turns. Undoubtedly, global risks and fears of a double dip will also play a role in the decision, but taming prices is a much bigger battle.
According to Mole Hau of BNP Paribas, latent inflationary pressure also continues to accumulate with administered electricity prices, which are worth 3.5 per cent of the WPI basket, yet to respond to recent increases in coal prices. Electricity tariffs are now being hiked in some states, suggesting these risks are crystallising.
What may worsen the situation is another round of quantitative easing (QE) by the USA, in order to combat chance of a double dip. If QE3 happens then commodity prices may rally again, making it rather difficult for the central bank to manage inflationary pressures. What this could mean is that, RBI may not be averse to slowing the economic growth rate to below the trend level of eight per cent (with further rate tightening), to deal with volatile inflationary pressures.
