Inflationary pressures intensified beyond its baseline projection

A rise in policy rates is imminent as the new financial year was greeted with a higher inflation and further pressures on prices of essential commodities due to supply-side bottlenecks. Markets believe that the fear of spreading the price rise to manufactured goods is likely to prompt the central bank to take more monetary measures to contain inflation.

Higher prices of milk and pulses drove food inflation up to 16.35 per cent for the week ended March 20 compared with a four-month low of 16.22 per cent recorded in the previous week.

Pulses were dearer by 31.55 per cent, milk by 18.74 per cent and wheat by 13.5 per cent on a year-on-year basis. On a weekly basis, the index for food articles went up by 0.6 per cent owing to higher prices of pulses (moong, urad and arhar), barley, milk, and condiments and spices.

However, as a sign of inflation becoming a demand-driven issue, the price rise in manufacturing moved up to 7.4 per cent in February from 6.5 per cent in January. The fuel price index rose to 12.75 per cent for the week ended March 20 — propelled by a hike in domestic fuel prices and an upswing in world crude prices — higher than 12.68 per cent in the previous week.

The overall inflation, which includes a combination of prices of food and non-food items, was 9.89 per cent in February and is estimated to cross the double-digit-mark soon.

Balancing act

‘Growth' was no doubt Finance Minister Pranab Mukherjee's watchword when he presented his budget for 2010-11 on February 26. Mr. Mukherjee's precision-perfect balancing act could be gauged from the fact that he kept the captains of industry in good humour, even while setting aside huge sums of money for the social welfare schemes.

Similarly, he maintained that his budget had taken care of the needs of “Aam Admi”, even while greeting middle classes with a slew of tax concessions.

Despite the “feel-good” atmosphere sought to be created by the Finance Minister through his budgetary proposals, the rising prices of essential commodities, particularly the food items, continue to be a major concern.

Fiscal discipline

Though fiscal discipline has been one of the main agendas of the UPA Government, the liquidity (funds) available with people has on the one hand spurred consumption, but on the other is contributing to rising inflation.

No wonder that the cascading effects of Pranab babu's fiscal measures has put pressure on the Reserve Bank of India (RBI) to increase interest rates. Effective March 19, the RBI has raised short-term indicative rates by 25 basis points. Markets are expecting another rise in interest rates, when the RBI Governor announces the central bank's annual policy for 2010-11 on April 20.

Inflation bound to rise

The Finance Minister has already acknowledged that his tax proposals would have a “marginal inflationary impact”. His argument is that while preparing the country's economy for a higher growth trajectory, inflation is bound to rise, especially in view of the fact that the Government has to mobilise resources.

But, in the process, the common man and the poor would have to bear the brunt of the price rise. The moot question is: Has the government have measures to protect the interests of a large section of the underprivileged in the society?

In his first post-budget interaction with industry chambers Mr. Mukherjee said: “I do agree that my tax proposals will have some inflationary ingredients and we have calculated it will be about 0.41 per cent. But in course of time it will be absorbed”. The Finance Minister went on to stress that he took the “risk of having a little inflationary pressure” to raise additional resources to enable a reduction in government borrowing this year and return to fiscal consolidation.

Additional revenue

The government can now expect an additional revenue of Rs. 40,000 crore by way of hikes in excise and restoration of duties on petroleum products, a fallout of the Finance Minister's decision to roll back stimulus packages announced in the backdrop of the earlier global recessionary trend. At the same time, the government stands to lose Rs. 21,000 crore by way of income tax concessions.

Of the anticipated additional revenue of Rs. 40,000 crore, the two percentage point increase in excise duty accounts for Rs. 14,000 crore, while the remaining Rs. 26,000 crore is to be mopped up from duty changes in petroleum products.

Even though some of the allies of the UPA government have rooted for a rollback — at least hike in the diesel price — to avoid a likely impact on prices of essential commodities, Mr. Mukherjee has preferred to defend his taxation proposals by saying that the rising Wholesale Price Index (WPI) inflation was mainly due to higher prices of wheat, sugar, pulses and rice, and this needed to be tackled by improving the supply-demand mechanism and not through monetary instruments.

However, the fear of demand-push inflation would make the central bank to implement more monetary policy measures to tame inflation.

Markets have already priced in another rate hike of at least 25 basis points this month. But the current trend indicates that this may not be enough. The Prime Minister too asked the central bank “to ensure that inflation is kept under control since it hurts the common man the most and also distorts economic signals.”

While raising the indicative short-term rates on March 19, the RBI stated that “the developments on the inflation front are a source of growing concern..... The acceleration in the prices of non-food manufactured goods and fuel items in recent months has been of particular concern.”

In the third quarter review of monetary policy in January, the Reserve Bank had raised the cash reserve ratio (CRR) by 75 basis points in two stages.

Since then, while the recovery in growth has proceeded broadly along expected lines, the inflationary pressures have intensified beyond its baseline projection.

More importantly, the rate of increase in the prices of non-food manufactured goods has accelerated quite sharply. Furthermore, increasing capacity utilisation and rising commodity and energy prices are exerting pressure on overall inflation. Taken together, the RBI noted, “These factors heighten the risks of supply-side pressures translating into a generalised inflationary process.”

A demand-driven inflation is waiting at the door-step of Indian economy.

Keywords: inflationeconomy

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