Inflation rears up again, interest rates will go up

Inflation is on the march. In May 2011, the wholesale price index (WPI) breached the 9 percent mark again to reach 9.06 percent, after falling to 8.7 percent year-on-year (y-o-y) in April.

As the Reserve Bank of India becomes hawkish on inflation, the May numbers make a rate hike in the near future almost a certainty. Danish Siddiqui/Reuters

And it's not all about food prices. Manufactured products inflation accelerated while that for primary articles and the fuel group declined (see table). But with diesel, kerosene and cooking gas prices still to be adjusted upwards, there's no guarantee the fuel group will stay stable in future.

But it is not just the increase in inflation figures that is worrying. Continued upward revisions to previous months' figures are also a cause of concern. The March 2011 inflation figure has been revised from just over 9 percent to as much as 9.7 percent.

Firstpost had argued in a previous post that inflation is probably much higher than the numbers reflect. In other words, the April dip below 9 percent that we had observed was probably more illusory than real going by previous revisions.

The actual figures aside, what do the latest figures mean for the economy at large? They actually answer one question, and raise another.

The demand side component of inflation can roughly be represented by manufactured products figures, which have risen to 7.3 percent - its highest level since October 2008.

With the Reserve Bank of India (RBI) showing signs of becoming an inflation hawk the last time, the May inflation numbers make a rate hike in the near future almost a certainty. This answers a question on what the RBI will do at its June 16 monetary policy meeting. It will raise repo rates, probably by 25 basis points. (The repo is the rate at which the RBI lends money to banks; 100 basis points make 1 percent).

The puzzle now is this: if growth is slowing down, why are prices still rising? Industrial production (IIP) numbers have been softening for months, and the latest GDP release also shows a particular decline in industry figures even if we account for a higher base effect.

But, manufactured products inflation has still risen. We have pointed out earlier to a disconnect between agricultural prices and output, and a similar question is presenting itself with respect to manufactured products. The situation presents itself, albeit in a different form, again.

Published Date: Jun 14, 2011 03:14 pm | Updated Date: Dec 20, 2014 05:05 am