Inflation is out of the bag

Inflation in India made quite a comeback in March. Unlike December, when the price spurt was led by high food prices, the surge this time is driven by rising core, or demand-side, inflation. Worryingly, this uptick in inflation looks like it would persist. Input cost pressures remain high, and this is hurting margins across various sectors. Reasonably firm demand means these costs are likely to be passed on to consumers, thus aggravating core inflation further.

Moreover, an impending fuel price hike and expectations of double-digit inflation risk adding to inflationary pressures. Despite these upside risks, the Reserve Bank of India (RBI) may set its wholesale price index projection at around 6 per cent year-on-year by March, 2012.

Unlike inflation, the growth outlook is mixed. Concerns on growth have emanated due to weak industrial production and a sluggish investment cycle. Consumption demand remains unhindered, thanks to continued government spending, rising incomes and improved consumer confidence. Booming exports are another positive. With conflicting forces at work, some moderation in growth is may be expected and RBI is likely to project real growth in gross domestic product at 8 per cent in the year ending March 2012.

The balance between growth and inflation has become trickier. Rising core inflation calls for an aggressive rise of 50 basis points in policy rates. However, concerns on the investment front argue for gradual policy tightening, raising the rates by 25 basis points. We prefer the baby-step approach, but this would mean the cycle would be prolonged. In the end, persistent high inflation, despite 350 basis points of effective tightening, suggests slower growth in the near term is a necessary evil to contain inflation in the medium term.

The writer is an economist with Nomura Financial Advisory and Securities (India)