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LATEST NEWS UPDATES | In India, an Inflation Dilemma -Anant Vijay Kala

In India, an Inflation Dilemma -Anant Vijay Kala

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published Published on May 15, 2012   modified Modified on May 15, 2012

Inflation in India rose above expectations in April, making life difficult for the nation's central bank as it tries to revive an economy facing increased stagflation risks.

The Reserve Bank of India last month cut its policy rate for the first time in three years to boost sagging growth. But inflation has remained stubbornly high, raising concerns the economy may be facing a nightmare scenario of slowing growth and rising prices.

On Monday, the government said the benchmark wholesale price index rose 7.23% in April from a year earlier. That was above 6.89% growth in March and significantly higher than economists' expectation of a 6.67% rise. In such a scenario, the central bank may not have much room for further rate cuts despite calls from business for cheaper borrowing costs to spur growth.

"With India looking rather stagflationary at present, the RBI faces somewhat of a dilemma—does it ease policy further on the basis that economic growth is very weak and core inflation soft or keep rates unchanged as it worries about headline inflationary pressures?" said Robert Prior-Wandesforde, an economist at Credit Suisse.

Inflation has eased from a high of 10% in September last year, helped by the central bank's tight monetary policy for much of the past three years. That pushed the central bank last month to cut its key rate by 0.5 percentage point to 8%. But inflationary pressure has remained a risk due to a number of factors. The government's large fiscal deficit—due to big fuel subsidies and welfare spending—has caused jitters among investors. A growing trade deficit, pushed up by the high cost of oil imports, has further unnerved investors.

Traditionally, India has used the wholesale-price index—which measures bulk sales between corporations—to gauge inflationary pressures, because it has a larger and more-representative basket of commodities than the consumer price index, which included obsolete items such as typewriters and didn't collect data from all regions of India.

But the wholesale-price index doesn't include services, which today account for about half the country's economic output. The government has introduced a new, more-accurate CPI, which planners hope will give monetary policy makers a more accurate representation of consumption trends and a better sense of inflation across the economy. The new CPI is ultimately intended to replace the WPI as the main gauge for inflation, but it will take a few years before there are enough historical data on this new series to make it the benchmark.

Meanwhile, foreign-capital flows into India have slowed amid concerns over the government's failure to carry out changes intended to make it easier for foreign investors to put money here.

The inflation data sent further shivers through markets Monday. The rupee sank to a near-five-month low of 53.91 to the U.S. dollar. A weaker rupee adds to inflationary pressures by pushing up the costs of imported goods. The benchmark 2021 bond fell to 101.51 rupees from an intraday high of 101.73 rupees before the data, while the Bombay Stock Exchange's Sensitive Index fell 0.5% to close at 16215.84.

C. Rangarajan, chairman of the prime minister's Economic Advisory Council, on Monday rejected the suggestion that India was heading into a stagflationary cycle, saying the economy would expand slightly more than 7% in the fiscal year that began April 1. This will be quicker than India's 6.9% growth last fiscal year, the weakest pace in three years.

Still, he acknowledged that inflation remains a concern and would limit the central bank's room to maneuver this year.

There were some bright spots in Monday's data. Despite a pickup in headline inflation, officials pointed to a slowdown in price rises in the manufacturing sector—a proxy for measuring price pressures excluding volatile food and fuel prices. This is known as core inflation.

Finance Minister Pranab Mukherjee said Monday he was comforted that manufacturing inflation, which accounts for two-thirds of the basket of goods used to calculate prices, has declined steadily from more than 8% in November to 5.1% in April.

Some economists say the reduction in core inflation might give the central bank confidence to cut rates by more than a percentage point during the rest of this year. Others say food and fuel inflation will limit the cuts.

The Reserve Bank of India next reviews monetary policy on June 18. The central bank will have May inflation and April industrial output data to study before then.

The "upside surprise in headline inflation is an issue, but not a game changer for the RBI," Barclays Capital said in a research note. "If we see more softening in core prices, the headroom for the RBI to support growth more is likely to expand, especially after the recent weak production numbers."

Data released last week showed India's industrial output in March contracted 3.5% from a year earlier, reflecting the sharp slowdown in economic activity.

The Wall Street Journal, 14 May, 2012, http://online.wsj.com/article/SB10001424052702304192704577403331263290996.html

Tagged with: Inflation



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