India heads major economies in the inflation sweepstakes. This could jeopardise recovery.
Headline inflation has crossed over again into double digits, resurrecting the spectre of runaway prices and interest rates. The 10.2 per cent rise in wholesale inflation during May provides cause for concern because the price rise has worked its way from food and energy and into manufactured goods. However, the 6.4 per cent rise in prices on the factory floor in May needs to be read in context.
Inflation in manufactured products’ prices was higher at 6.6 per cent in April and the movement in May was principally driven by a spurt in metal prices. The ongoing crisis in the eurozone has had a positive spin-off in keeping international commodity demand suppressed and the May spike is unlikely to endure. The larger picture suggests inflation this year should begin to ease off by July when last year’s drought worked up a storm in food prices. On balance, the government may not be too out of line when it sticks to its target of 5 per cent for 2010-11; March could well be the high point at a revised 11.04 per cent from which inflation ought to trend down.
Yet the supply side pressures have not abated. Food and fuel are individually contributing twice as much to headline inflation as is manufacturing. This, alongside a declining trend rate, makes the argument for ‘policy tightening’ less convincing. The largesse from the auction of radio frequencies to telecom companies lessens the imperative for fiscal rectitude while monetary tightening need not shift to a shorter trajectory unless demand-led inflation makes its presence felt more forcefully.
The central bank’s rate hiking cycle will continue to factor in liquidity, credit growth and the overall economic recovery. It also stands to reason that the Reserve Bank of India (RBI) will now move on rates only when a more responsive transmission mechanism is in place after July 1, when banks switch over to prime rates that act as floors and not ceilings. The RBI, as banking regulator, has worked hard on fixing this structural rigidity. It must be eager to see how attentive the new system is to signals beamed from Mint Road.
Inflation visiting India over the past 12 months holds out a sobering lesson for our policymakers. The main push to the price line has been from primary articles — food, fuel, metals — which the demand manager’s arsenal can do little to repel. Demand compression, as and when its need is felt, could jeopardise India’s recovery.
Already, India heads the list of major economies in the inflation sweepstakes, and as more parts of the globe climb out of recession expect the energy and commodity cycles to exert greater pressure on our price line.