Inflation spike means RBI won't say 'Subbarao khush hua..'

All bets are off on an RBI rate cut for now. Going by the central bank’s insistence on taming inflation, the spiral in the August print and the sharp upward revision in the June figure make it a foregone conclusion. Well almost.

An indication is RBI Deputy Governor KC Chakrabarty’s reiteration at the right moment -even as the inflation figures were being flashed across TV channels-that the RBI’s top priority is inflation.

But it is not that easy for the RBI as the situation now is trickier than earlier. The pushes and pulls on it are much stronger.

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The factory output in July was near zero. The diesel price increase announced yesterday will push up the inflation further and at same time indicate the government may finally get cracking on the fiscal front.

Adding to the worries will be the QE3 unleashed by the US, which is sure to lift the prices of commodities and in turn Indian inflation.

Analysts and economists expect the diesel price increase to spike the inflation rate by 65 basis points.

The RBI Governor had told Parliament’s standing committee on finance that an increase in fuel price will result in a 2.6 percent spike in inflation in due course.

“The ideal situation would be a 7 percent growth and 5 percent inflation,” he was reported to have told the panel.

The RBI’s perfect understanding of the situation notwithstanding, the government is likely to put pressure on it to get moving on rate cuts.

For a while now, the central bank has insisted on government action to contain the deadly twin deficits-fiscal and current.

Yesterday’s diesel price increase has been perceived as a signal that the government is willing to take tough steps to rein in the deficits, at least to an extent. In addition, it is likely to succeed in getting the much-delayed FDI in aviation today.

So, the government is likely to feel that it has the right to push the RBI to cut rates on Monday itself. And the mandarins at North Block are unlikely to see the fact that the Rs 5 increase in diesel price is like a drop in the ocean.

“….The subsidy cut (owing to ) is a fleabite on an elephantine deficit,” a Firstpost article has said.

“Fixing the hole in the budget will take a lot more effort than just one diesel hike. For the record, even after the diesel hike and the limits placed on subsidised cylinders, the oil subsidy bill will come down by just around 10 percent-from nearly Rs 2,00,000 crore to Rs 1,80,000 crore. Or thereabouts,” it said.

And FDI in aviation, even if allowed, is unlikely to result in a sudden flood of foreign capital, given the bad shape the domestic sector is in.

Now, coming to the bond-buying plan announced by the US yesterday, the RBI has time and again stressed on the weakness of the global economy that is hitting Indian exports. For the fourth consecutive month, exports dropped in August. The nearly 10 percent fall is confirming the dismal global picture painted by the various data published over the last few weeks across the globe.

The government has done nothing to improve the export competitiveness of the country, which will help bridge the current account deficit.

Apart from these is the likely acceleration in the consumer price index-based inflation to be released next week. Considering the 7.55 percent WPI, the CPI is likely to return to double digits in August.

The diesel hike will make RBI Governor a bit less testy, but the inflation spike may not be enough to smile and say: “Subbarao khush hua…”.

Given these circumstances, the RBI is likely to stay put. After all, a rate cut is not a quick fix, and even if it is, a quick fix is not a long-term solution.