The Hindu Business Line : Expect some monetary measures soon

One realised later after looking at the break-up of the index that the minerals component of the primary articles had more than doubled over the last week. Prices of minerals could not have doubled in a week, they had been going up steadily but the index was not being updated. It was last updated only in April where again we had seen a one-time revision of almost fifty per cent.

So once the minerals index got updated, the headline inflation just hit the roof. Hence, it is incorrect to assume that inflation has suddenly started to get out of hand. It has been creeping up for some time; it is just that most of us were not aware of it, as the index was not being updated.

Now we come to the next question of the quality of this inflation. One keeps on reading in the papers how almost of it is a supply side problem. One often hears analysts say that the prices of commodities and oil are the primary drivers of this supply push inflation. A close look at the table will tell you that one cannot say with utmost certainty that all of the spike in prices has been on account of supply side factors, particularly oil.

If you compare the index components over last year, the manufactured product inflation is almost as high as the overall wholesale inflation.

The growth in primary article prices is actually lower than that of the manufactured products. Over the last three months though, the overall index has accelerated on the back of primary article and oil prices, but the manufactured product prices have also continued to rise at almost 8 per cent which by no means is worth ignoring.

At best one can say that this spike is an inter-play of both demand as well as supply side factors. In the last three months, the annualised wholesale inflation has actually moved into double digits.

Although I do not think that at this point the problem of inflation looks like getting out of hand, a continued rise in crude oil prices poses a real threat. The RBI committee that had first recommended the abolition of overnight repos and the launch of monetary stabilisation bonds had very clearly stated that the huge liquidity overhang in the system could put inflationary factors into play going ahead.

In fact, they had argued that sucking liquidity through short-term repos tantamounted to the money continuing to stay in the system and hence the need for MSBs.

In this background, I think it is quite likely that the RBI will take some monetary tightening measures. Restarting the overnight repo is not an inflation fighting monetary measure by itself, but a precursor to some.

I do not think that they will hike rates now but a one-time sucking out of liquidity to the tune of Rs 20,000-25,000 crore through a combination of a CRR hike and MSBs cannot be ruled out.

If inflation continues to be stubborn then one can expect a hike in the October monetary policy. But the liquidity tightening exercise should start sooner than later.

There is another theory doing its rounds that the RBI might sell dollars aggressively and push the dollar-rupee lower. This will not only lower the imported inflation but will also remove liquidity.

I only partly agree with this view. I have rarely seen the central bank push the rupee to an artificial and unsustainable level; they have always endeavoured to reduce volatility and have let the rupee slowly find its equilibrium.

In the current scenario, if the rupee comes under pressure because of oil demand or otherwise, we can expect the central bank to aggressively protect the 46.50 level. It can dispense with a few billion dollars from its abundant reserves and not let the rupee depreciate quickly, thereby enhancing the problem of imported inflation.

But it is unlikely that they will sell at all levels and cause the rupee to actually appreciate significantly, more so because the current spot rate is quite close to the theoretical REER (real effective exchange rate) level.

(The author is senior trader, Interest Rates at HSBC Mumbai. The views expressed herein are his own and not necessarily those of his employer.)

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