High Inflation, Slow Growth - What Will The Government/RBI Do?

March 30, 2008

The Wholesale Price Index (WPI) inflation number for the week of 15th Mar came out at 6.68%, crossing the 6% mark sooner than analysts' expectations. In two weeks, the WPI inflation has gone up by 1.64%, which is quite a bit. The increase is seen across the board but the biggest contributor in this jump is 'iron and steel' - its contribution has moved up from 7.7% on 1/Mar to 18.30% on 15/Mar.

The finance minister has made it clear that he would compromise on growth to curb inflation. Naturally expected from him. The Index of Industrial Production (IIP) figures for Jan/08 was at 5.8%, less than 7.7% recorded for Dec/07 and India is expected to grow at 7.0% to 7.5% in the coming year. Though this is a slowdown as compared to the previous year, we, along with China, are still better off than other countries in terms of growth. And we are definitely better off than other countries (including China) when it comes to inflation, even at these high levels.

Why is there a jump in inflation? Inflation jump now is not due to high demand but due to supply issues. In order to address this, the government would have to do something. They can try and stall export of items like iron and steel (which has anyway contributed significantly to the inflation figure). This does not augur well for companies that produce them but tough luck. This is not new to India. There are a lot of countries now who are undertaking the measure of curbing exports as they are facing a similar situation as us.

What else can the government do? A decrease in import duties? It may help, but may not help much. This is because the prices of commodities that we import themselves are quite high in the global markets now.

What can the Reserve Bank of India (RBI) do? The monetary policy announcement is due on 29/Apr. Given that the current inflation is due to supply side issues, tinkering around with rate would not be the best thing to do as of now. So, there is little probability that RBI would increase the repo rate. 

The RBI would need to provide some kind of a signal to the markets to curb inflationary tendencies. They would, in all likelihood, use a CRR hike to do that. One more thing that they would do is to absorb excess liquidity through MSS. The current cap on the MSS is around Rs. 250,000 crores and the outstanding under that is around Rs. 170,000 crores. So, there is a bit of room for the RBI there which they would use. There are some reports that the RBI may allow rupee appreciation - that may work partly as well.

One thing is for sure, there would definitely be some action by the RBI. This is because my view is that this 6+% inflation figure is no blip, the inflation would stay above 6% in the coming weeks.

Ramki is working in financial services sector in Mumbai, India and is interested in investing and tracking the stock markets. Publishes a blog on Indian Stock Markets that analyses daily market movements and the factors influencing them. Views expressed here are personal.
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High Inflation, Slow Growth - What Will The Government/RBI Do?


Author: Ramki


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