Twice bitten, now shy: RBI keeps close watch on inflation

Last Updated: Thu, Jul 05, 2012 19:13 hrs

Even after entering a rate reversal cycle, the Reserve Bank of India (RBI) is refusing to give up on its fight against inflation. Caught off-guard on inflation projections in the past two years, it is maintaining a hawkish stance.

Yesterday, RBI Governor D Subbarao said the central bank was "deeply sensitive" to the problem. "We are committed to bringing inflation under control. It has been our effort over the last two years and will continue to be our effort," he said.

In April, the central bank reduced the repo rate for the first time in three years, to boost slowing economic growth. Though market participants expected the easing to continue, RBI held rates in its mid-quarter policy review last month, diminishing hopes of cuts in the near future. It is scheduled to announce the first quarter monetary policy review on July 31. Most market participants rule out any reduction in policy rates, given the central bank's hawkish stance and keen eye on inflation trends.

While the core or non-food manufactured items’ inflation stabilised at around five per cent in the past three months, food’s has increased, pushing up the overall headline inflation as measured by the Wholesale Price Index (WPI). More, RBI mentioned in the mid-quarter policy review that retail inflation had continued to stay high.

According to economists Taimur Baig and Kaushik Das from Deutsche Bank, the macroeconomic environment has turned stagflationary, with significantly below-trend growth and significantly above-trend inflation. "RBI is unlikely to quarrel with this observation, even if it won't use the term. More important, we don't think the central bank sees growth rising or inflation declining appreciably in the near term," they wrote in a report.

They added inflation was expected to stay high on factors such as the possibility of a poor monsoon, pass-through impact of the rupee's sharp depreciation, strong consumption supported by fiscal subsidies and persistent supply bottlenecks.

"If the government does not increase fuel prices, RBI may not have the space to cut and the economy could suffer," said Sonal Varma, economist at Nomura.

In the current financial year, the headline WPI continues to stay above RBI's projected level of 6.5 per cent. It was 7.23 per cent in April and increased to 7.55 per cent in May.

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