Inflation in India set to reach 9%

India's annual inflation rate is probably already near nine per cent, close to a 13-year high, and will top the central bank's comfort zone all year as the impact of rising raw materials prices seeps deeper into the economy.

But since price pressures are largely beyond its control, the central bank will maintain a measured response to fight inflation by managing cash levels in the banking system rather than raising interest rates, which could impact growth, economists said.

A potential rise in pump prices to offset pressure on government subsidies, plus tax cuts and higher federal government salaries that could fuel demand, are expected to keep pressure on inflation in coming months.

If recent and persistent upward data revisions are anything to go by, Friday's data showing inflation hit 8.1 per cent in the year to May 17 will not be the peak.

"We may see nine per cent to 9.2 per cent peak in the near term after the revision to the provisional data," said Sujan Hajra, chief economist at brokers Anand Rathi Securities. The latest figure for the wholesale price index, the most closely watched inflation measure in India, marked its highest level in more than three-years and was well above the central bank's target of 5.5 per cent for the end of 2008/2009 next March.

But a rate of nine per cent would be the highest inflation since 1995.

The big revisions in the data are due to a time lag in updating domestic prices of international commodities such as iron, steel, edible oils and petroleum prices. With world oil at record highs, the government is debating whether to raise pump prices again. It raised diesel in February by 3.3 per cent and petrol by 4.6 per cent.

Economists say a 4.6 per cent to nine per cent rise would add between 50 basis points and 100 basis points to headline inflation.

"If oil prices keep rising we will see some raise in local prices in the future, which in turn would mean some monetary policy action will be required," said Sanjeev Sanyal, chief Asia economist at Deutsche Bank in Singapore. The Reserve Bank of India has lifted the reserve requirement for banks by 2.25 percentage points to 8.25 per cent of deposits since April 2007. But it has left interest rates steady for more than 12 months, concerned growth may be slowing from close to nine per cent in the last fiscal year.

Economists say the reserve requirement could rise by as much as one percentage point to keep interbank rates at the top end of the official six per cent to 7.75 per cent rate corridor.


 

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