Headline inflation puts RBI in a fix

A continuing surge in food prices pushed headline inflation to 7.55 per cent in May from 7.23 per cent in April, rendering it slightly trickier for the Reserve Bank of India to decide on whether to initiate monetary steps to spur flagging growth or hold the policy rates for now to contain the price spiral.

Even as stock markets — which had been eyeing a repo (short-term lending) rate cut of 25 basis points at the least by the RBI on June 18 — tanked on inflation concerns, analysts are still hopeful of a monetary easing as the fresh spurt in WPI inflation was due to a spike in food prices, which continue to suffer from supply-side issues and not on account of core inflation.

As per the WPI data, it was overall food inflation that spiked to 10.74 per cent in May from 10.49 per cent a month ago. On the contrary, manufactured inflation eased somewhat to 5.02 per cent from 5.12 per cent in April, although the ‘fuel and power' segment inflation in May stood pegged at 11.53 per cent year-on-year, a tad higher than 11.03 per cent in the previous month. Aptly describing the apex bank's dilemma was Nomura India economist Sonal Varma, who said: “The key issue before the RBI is whether to support flagging growth momentum or tackle inflationary pressures.”

However, what may clearly tilt the scales in favour of a rate cut next week are two other developments. First, the official trade figures which added to the economic woes and the other was Moody's, which viewed that the Indian economy was in for a phase of stagflation — a double whammy of low growth coupled with high inflation.

According to the provisional trade data, the country's exports slipped by 4.16 per cent to $ 25.68 billion in May, ostensibly owing to the continued slump in global demand following the euro zone crisis and the consequent slide in domestic industrial growth. But a more worrying factor is the marked decline in imports by 7.36 per cent to $ 41.9 billion, primarily on account of plant and machinery imports falling by 8 per cent.

When correlated with the IIP (index of industrial production) data, it not only signals a weakening economy but also explains the massive contraction in capital goods output which, in turn, reflects a fall in business sentiment and investor confidence. “We have also seen the IIP numbers. So you can correlate the reasons why exports have not done too well...,” Commerce Secretary S.R. Rao said.

In its analysis of the country's economic scenario, global financial services Moody's noted that India was facing stagflation and, therefore, the central bank cannot afford to be aggressive in cutting the interest rates. “India's economy is in stagflation, with notably weaker growth but inflation still stubbornly high… Yet with the inflation numbers now being driven by supply-side factors, and with the currency being pushed downwards...and India's weaker growth prospects, we think that the RBI could cut rates without it putting too much upward pressure on inflation,” Moody's Analytics senior economist Glenn Levine said.

As for the government, Finance Minister Pranab Mukherjee expects inflation to hover around 6.5-7.5 per cent this fiscal on back of a good monsoon. “I am confident that range of inflation would be around 6.5-7.5 per cent throughout the year. I hope if monsoon is quite good, then it would be possible that this type of pressures would be sorted out,” he said.

As during the past months, Mr. Mukherjee maintained that to contain the price spiral, the government would “have to address supply constraints, [and issues concerning] cold chaining and warehousing facilities.”