Concern over another inflationary cycle

Survey suggests rolling back of excess liquidity from system.

Even as headline inflation, as measured by the wholesale price index (WPI), declined further in negative territory to stand at minus 1.3 per cent, the Economic Survey raised concerns of another inflationary cycle because of the expansionary monetary policy adopted to tackle the global liquidity crisis.

The survey suggests rolling back of excess liquidity from the system in an orderly manner.

Average inflation rate for the previous financial year ended March 2009 is 8.4 per cent, in which inflation peaked at double digits from June to October in 2008. The rate started to fall in the beginning of 2009, owing to drop in international crude prices and went into negative territory three weeks earlier.

The Reserve Bank of India (RBI) has predicted the inflation rate to be around 4 per cent by March 2010, with the growth rate at 6 per cent.

After the collapse of Lehman Brothers in September 2008, capital flows reversed and Indian companies were not able to tap loans from abroad. This led to liquidity crunch in domestic markets. RBI responded by decreasing cash reserve ratio (CRR) and statutory liquidity scenario (SLR). Since September, both CRR and SLR have been reduced by 400 basis points to facilitate flow of liquidity in the economic system. This has led to huge influx of liquidity into the system. Now the fear is that it might fuel inflation.

Moreover, deseasonalised WPI data, which accounts for seasonal variations to forecast inflationary trends, indicates the period of deflation will have a short tenure and will end by the end of 2009, after which inflationary pressures are expected to emerge again owing to rising food and fuel prices.

The survey attributed the gap between the WPI and the consumer price index (CPI) to the inability of the supply chain to keep up with the growth in income and consumer demand.

Consistently rising food inflation, which has marginally moderated in the last two weeks, is expected to create a pressure point.