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| Experts debate rollback of lenient policy |
| Devika Banerji / New Delhi Dec 19, 2009, 01:08 IST |
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With food inflation scaling a decade high of around 20 per cent for the week ended December 5 and the overall headline inflation rate for the month of November at 4.78 per cent, economists and policymakers have started debating about the rollback of a lenient monetary policy that was put in place to inject liquidity in the system during the crisis period.
Experts say the headline inflation, as measured by the Wholesale Price Index (WPI), has been primarily rising due to consistently rising food inflation as other category of fuel inflation continues to be in the negative zone, while the inflation rate for the manufactured goods category was in the range of 2-3 per cent in November.
This is different from the situation last year in August when the headline inflation touched 13 per cent, driven by rapidly surging oil prices.
Along with this, the economy was feeling the heat as credit inflows accelerated the inflation rate.
The mid-term review report by the Ministry of Finance also observes that inflation this year has been an “unusual and skewed”. “The very fact of its skewedness seems to suggest that this inflation is not a product of aggregate demand expansion in the economy. Its dominant cause is the supply side one of reduced food production or, more accurately, the expectation of a reduction is food production over the next months that the drought and poor monsoon in India have definitely given rise to,” observed the report.
This year, the liquidity in the market, on the other hand, has dipped after the outgo of third tranche advance corporate tax payments on December 15. RBI’s absorption of liquidity though reverse repo operations has declined in the last four days. It had mopped up Rs 90,665 crore on December 14, and today it absorbed Rs 53,990 crore.
Adding to this, credit growth, which has picked up pace at 10.5 per cent in the fortnight ended December 4 is still a significant deceleration since it registered 17-18 per cent growth in the April-May period. There are even apprehensions regarding the momentum of credit growth in the coming months.
Given such a macroeconomic scenario, analysts believe that policy rates like repo and reverse repo and other controlling rates like Cash reserve ratio (CRR) might be raised by the central bank, however this might not bring the inflation down as the current inflationary pressures on the economy is driven by supply side constraints which has led to steep rise in food prices.
“It is absolutely right that excess liquidity is not the reason why inflation is going up and monetary tools will not be absolutely appropriate in bringing down food inflation as the concerns are supply side driven. However, the RBI will have to anchor the monetary situation keeping in mind the inflationary expectations as there might be some easing on food supply in the coming months and credit growth is also expected to pick up,” said Shubhada Rao, chief economist, Yes Bank.
Inflation driven concern is build on long term scenario where a constant rise in food inflation will lead to a high Consumer Price Index (CPI) which will spiral down to increase in wages coupled with higher retail prices . This leads to higher costs of production and result into higher interest rates. However, economists believe that higher inflation rate might not radiate down to interest rates in the short term and soft lending rates will continue for some time even as inflationary pressures exist as the economic recovery is not yet very firm.
“The interest rates will increase only when there are indications that economic recovery is more firm. Credit growth will be an indicator that will matter and is expected to pick up. Inflation will have to be controlled by monetary tools but it is more taking into consideration the inflationary expectations as food inflation might radiate down to manufactured category,” said DK Joshi , principal economist with credit and ratings agency CRISIL .
Most analysts expect a rise in CRR by January 2010 and an action on policy rates like repo and reverse repo by March- April 2010.
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