Not enough solace in quantum of showers

Last week a senior official from the Reserve Bank of India (RBI), the country's central bank, was in town on a private visit. I met him at a friend's place. During the course of the conversation, I tried to get his assessment of the state of the economy.

He was very positive about the prospects for economic growth, and said the privatisation programme is easing concerns regarding the funding of the central government's budget deficit, allowing RBI to pay closer attention to dealing with inflation expectations.

I posed a subtle question on that issue, to gauge the RBI's house view on a potential interest rate hike on July 27 (the timing of the next scheduled policy meeting). The official cleverly ducked my query and gave a long story on how the south west monsoon is picking up momentum after a weak start, and how it will lower food prices and help halve inflation to 6 to 7 per cent by this year-end. For a moment I suspected the guy moonlighted for the meteorological department.

India's inflation accelerated in June, increasing pressure on the central bank to raise interest rates for a second time this month. The benchmark wholesale-price index jumped 10.55 per cent from a year earlier, after a 10.16 per cent gain in May. The reading for April was 11.23 per cent, a 19-month high. Consumer prices paid by industrial and farm workers in India increased by almost 14 per cent, the most among 17 countries tracked by Bloomberg in the Asia-Pacific, including China and South Korea.

Looking back, the initial spike in inflation in the October-December quarter of 2009-10 was driven by primary goods. Over the last six months, price pressures have shifted from agricultural to industrial commodities. So there is a clear indication that the economy is starting to overheat.

Everyone is expecting the RBI to act soon. If inflation persists at more than 10 per cent, "some action" by the Reserve Bank is required, Chakravarthy Rangarajan, a former RBI governor and chairman of the Prime Minister's Economic Advisory Council, said last week. The RBI could raise the repo rate (the rate at which it lends to banks) by another 50 basis points by the end of December, a recent Reuters poll of 21 economists showed.

The inflationary pressures from the recent fuel price hike are expected to be played out in July inflation figures. On June 25 the government allowed state-run refiners to raise prices of petrol and diesel in a bid to cut fuel subsidies and narrow the budget deficit from a 16-year high.

The government has been under pressure to control runaway price increases, more sharply felt at retail levels. The fact that inflation has crossed the psychological benchmark of 10 per cent means the onset of all-round pressure to take action to rein it in.

On July 5, all major opposition political parties organised a nationwide strike to highlight the issue. Under these circumstances, the pressure is mounting on RBI to implement a further rate hike this month.

Rate hike prospects

The RBI is widely expected to raise key rates by 25 basis points in its policy review later in July, after three rate hikes this year, including a quarter of a per cent raise in key policy rates on July 2. The sharp revisions in the headline inflation number in March and April have maintained the case for further monetary tightening by the central bank both on July 27 and even after that.

The meteorological department has forecast that the June-September monsoon rains, the main source of irrigation in India, will be sufficient for farming. The government and the RBI are relying on lower food prices this year to cool inflation.

Yet, even if those rains are better than expected, it may not be enough to cut price increases adequately, as my RBI contact tried to convince me last week. More than that may be needed to dampen the inflation stats.