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FINANCIAL SCENE

Inflation to feature in RBI review

Official concern sets off quick remedial measures on supply side


The Government has been stepping in aggressively with supply side measures.

RECENT INFLATION data have set off alarms in official circles. For the week ended January 6, the rise in WPI (wholesale price index) was 6.12 per cent, a good half percentage point higher than for the previous week.

Although the inflation rate has come down slightly to 5.95 per cent in the subsequent week, official concerns over the magnitude of price rise remain and have set off a number of responses to mitigate its effects.

Inflation has been creeping up steadily over the past two years. An inflation figure above 6 per cent was well within the realm of possibility.

Yet when the inflation data were released, and the rate was seen to be at its highest level in two years, no one was seen soft-pedalling the issue or hoping that the price rise would moderate in days to come.

Finance Minister P. Chidambaram, among others, did make the point that the sharp increase in inflation was partly due to the base effect. Last year, during the corresponding week, the WPI was declining marginally.

However, the price rise has been across a range of commodities — a large number of articles of day-to-day consumption as well as manufactured goods. The Primary Articles group, having over 22 per cent weightage in the WPI, has gone up by 9.28 per cent compared to last year. Food items cost much more, according to official statistics, by at least 15 per cent. Needless to add that costlier food and other items of everyday consumption are politically sensitive.

Supply side measures

The rise in consumer price index and its several variants is even higher, at 7 per cent and above.

Since inadequate supplies of these items have been responsible for the price rise, a long term solution may well lie in improving agricultural production and setting up a whole range of rural infrastructure such as cold storages.

Near term measures to alleviate the shortages and thereby moderate the price rise have, in the past, included imports of wheat and cereals and restraining exports of items such as sugar.

In a direct response to the high inflation numbers, the Government has effected import duty cuts with immediate effect on a number of items including cement, copper, zinc, stainless steel and capital goods.

It is not for the first time that such measures to ease supply side pressures have been undertaken. Last year import duties on some agricultural commodities including palm oil were brought down. It is expected that the forthcoming Union budget will bring further tariff reductions.

The Government has also suspended forward trading in urad dal and tur, two pulses of mass consumption, which have allegedly invited speculators' attention. This is a controversial move. It is not clear whether forward trading is responsible for the high prices.

It is more likely the high prices of these items reflect the demand-supply mismatch. Domestic production of these has not kept pace with the rising demand.

Threat on oil front

One supply side factor contributing to inflation not just in India but throughout the world has been the high petroleum prices. Although they have come down from their highs of nearly $80 a barrel to below $55, they remain a threat for a number of reasons.

Not many experts visualise oil prices coming down more substantially.

In India, of course, the retail pricing of petroleum products has been opaque involving direct subsidies as well as cross subsidies. Last November, the prices of petrol and diesel were reduced and in the wake of the recent falls in the crude prices there is a clamour for another cut. However, there is some resistance from the oil marketing companies which in the past bore the brunt of the increase in the crude price.

At a time when the economy is growing at a furious rate, inflationary pressures are on the ascendant. Supply side measures have relevance but with many sectors functioning at full capacities, it will call for unpopular measures such as more liberal imports to rein in inflation. Hence it is that demand side measures, always in the reckoning, will have to be brought to centre stage.

On January 31, the Reserve Bank will be reviewing its annual credit policy. Its target range for inflation for the year has been between 5 and 5.5 per cent and it will therefore be interesting to see what monetary tools will be used to achieve that goal.

The RBI is, of course, not compelled to vary its interest rate signals on the day it reviews its policy. But everyone will be surprised if it does not.

RBI intervention

Over the recent past, the RBI has been relying almost exclusively on the reverse repo and repo rates, the rates at which it borrows and lends against securities.

However, intervention through repo rates alone has had one limitation in that large foreign capital inflows that have become commonplace have become an alternative source of liquidity and reduced the dependence of banks on the RBI.

Realising this, the RBI resorted to a CRR increase of 50 basis points last month (December 8), a measure designed to impound Rs.13,500 crore of additional deposits.

The big question on the eve of the third quarter review is what other steps the central bank would take to tackle inflation.

Flexibility over SLR

The conduct of monetary policy has become even more challenging now, with the RBI finally getting the legal nod to lower the floor on SLR, which now stands at 25 per cent. The flexibility the RBI gets in conducting monetary policy is welcome. It fits into the reform agenda as well. One of its long-range goals is to progressively bring down the level of statutory pre-emptions — the CRR and the SLR.

However, at the present juncture, the RBI may announce a roadmap to lower the SLR but may not effect a change straightway. Among the factors influencing the central bank will be the state of government finances, the more than expected growth of all monetary indicators and of course inflation. Public finances at the Centre and in the States are reported to be in better shape with their fiscal deficits coming down thanks to a booming economy. A lower SLR floor suggests less reliance on the banking system to fund government borrowing.

For some time banks were investing in SLR securities far more than what they were required to.

More recently, however, they have been divesting their excess holdings to fund their borrowers. The present level of SLR is in the region of 29 per cent and is expected to come down further to 25 per cent. Hence banks will require additional leeway for raising funds through a lower floor for SLR only after some time. Of course, bank credit has been growing furiously with much of the disbursements allegedly leading to overheating of the economy.

The RBI has already made retail and home loans more expensive. Yet if credit growth continues unabated, other measures besides higher interest rate signals will in all probability be announced.

C. R. L. NARASIMHAN

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