Inflation at 11.42%: Are we heading toward 13%?

Inflation for the week ended June 14 is at 11.42% versus 11.05%. A CNBC-TV18 poll saw inflation for the week ended June 14 at 11.15%.

Inflation for April 19 has been revised to 8.23% vs 7.57% earlier.

Primary articles are up by 0.2%. Fuel, power and energy has gone up by 0.1% and manufacturing is up 0.6%. Food articles and textiles are up 0.7%.

Metals and alloys are up 0.3%, while minerals are up 3.6%. Food articles consisting of tea is up 3%, while fish, marine, milk and maize is up 1% each.

Non-food articles is down 0.5%. Out of which linseed oil is down 3% and groundnut and cotton is down 2% each.

Bankers believe with high oil prices, the olny way to bring down inflation is to curb aggregate demand.

YV Reddy, Governor, Reserve Bank of India, or RBI, said India is not an inflation targeting country. "It is difficult to identify the core for meaningful inflation target. There is little, or no support for inflation targeting in a political economy." He stated there is big progress in removing the mystique around the Monetary Policy. The RBI policy, in terms of framework and tools is gaining complexity, said Reddy.

Anant Narayan, Head of Treasury at Deutsche Bank is of the view that bond yields will not go up right now as there's no supply in the system.

Shubhada Rao, Chief Economist of Yes Bank is of the view that momentum is still there and it sees a 7% growth rate this year. While Mridul Sagar, Chief Economist at Kotak Securities sees FY09 GDP growth at about 7.9%, which may come off next year.

Excerpts from CNBC-TV18's exclusive interview with Anant Narayan, Shubhada Rao and Mridul Sagar:

Q: 11.4%, you would expect that? None of your expectations going forward are changing?

Rao: Not really at this point in time. I do not think that every 5 bps deviation from our expectation would alter expectations in the immediate horizon. As I said earlier, any nasty surprises, some more severe price adjustments would prompt us to review and rethink. But at this point in time I think where repo rate is concerned, Reserve Bank of India (RBI) has put a signal loud and clear for the banking sector to translate it into higher lending rates. In terms of liquidity mopping up, yes clearly we have seen CRR and we may possibly see a CRR and a reverse repo measures.

Q: There could be some iron and steel elements?

Rao: Iron and steel, we have seen the second round of impact now beginning to show; chemicals, machine, machinery tools, transport equipment, all these are clearly on the upside. If you look at edible oils and the food product side of manufactured edible oil, oil cakes, these are the pressure points that we would watch out for.

The second order on cotton textiles, although in recent weeks it was a bit stable, is now beginning to show on the manufactured products.

Q: How would you look at this 11.4% number itself and if you can be brave enough to guess where these numbers can peak off?

Sagar: Today’s number is also a bit on the higher side than what we were expecting; we were expecting close to 11.21% or 11.3% basically. Very clearly the path of the inflation is headed towards 13%-mark somewhere at the end of September or early October. That should be the peak because there are very strong base effects, which will drive up inflation plus the second round fuel price hike impact would be felt through the economy.

I wish after that the inflation moderates and that would not depend on the global factors, which will be turning around later in the year.

Q: Are you brave enough to guess where this thing can peak off because week-on-week, again it is a 0.4% rise, which would mean that by the end of the year, it is translating into a 16% inflation or thereabouts?

Rao: The first half of the year, I can completely concur with Mridul that the base effect is definitely going to play a larger role. We could see inflation trending up to 13% range. The last quarter is where we can see some beating off. The points that we need to carefully monitor are possible further increases in steel prices that are being talked about, those happen somewhere up to July and August.

Between the July and October review, a lot of directions will be sought for further monetary policy action because that is the time when you have the monsoon.

Q: Not in terms of time, but in terms of numbers, should one be prepared for very ugly numbers?

Rao: 13% is very much to be seen. I am not too sure whether I am going to see the highs of January, February and March of 1995, which saw an inflation of about 15-17% range. I am not too sure whether that is going to happen. But clearly the international environment, global crude oil prices and other commodities are so uncertain. We don’t know where the tipping point lies. Yes, one does see 13% on the charts when one calibrates those numbers going in.

Q: What are you expecting, by way of RBI action? At 11.42% and a manufacturing index going up at 0.6%, we cannot even claim that inflation is rising at slower pace. If you remember, last week manufacturing rose by 0.3%. Now if we rise every week by 0.3% then at the end of the year, the annual inflation rise would be 15.6% for manufacturing, which is 60%. That would itself give an annual inflation number of 11%. Now it is even double of that 0.6%; would you say that the peak off number finally could be very ugly? What's your guess both of that number and of RBI action?

Sagar: I guess 13% itself would be ugly, so in a sense whether 13% or 16%, the inflation trajectory changes not at more significant level to alter the direction of policy measures. My guess is that the RBI has taken these measures peremptorily, so in a sense that inflation so far has been largely a supply-side phenomenon. But they are probably concerned that it would become more general ahead, that we will see a general price rise and that is what they are watching out and not leaving surplus liquidity on the table for inflation to pickup from there. I hope the measures would work to that direction and the significant point is that this is an extraordinary spike; this is an extraordinary year.

We had seen earlier oil price shocks and if you remember, in 1980, inflation rates even in developed countries, were running around 16-17%. US itself was at 13%, so this is going to be a bad year. There are around 50 countries, which are already into a double-digit inflation. We are not unique in that, but if we are able to arrest inflation at 13% and it stabilises at that level, the job would have been done.

Q: Do you expect any scenario at all that the RBI may have to act even before July 29 or do you think the message has been sent out fairly well until then?

Sagar: I guess the message has been sent out. The signal was very clear, unambiguous and in a very strong fashion. We do expect lending rates to harden by 50-100-bps immediately. That would slowdown aggregate demand to the extent, which is desirable. Remember, retail credit growth is already in single digits for most banks, so one is not going to completely stop economic activity. The measure has been taken and probably if in the interim, there are extra signs that demand is continuing to rise, then probably we could see appropriate evaluation in the July policy.

Q: What are you factoring in the July policy itself?

Sagar: What we are factoring in is that we are expecting another 50 bps CRR hike, not necessarily in July, but sometime after that within the first half of this year and also another 25 bps repo rate hike. At the moment we are not seeing stronger tightening to come.

Q: A 25 repo will still take the repo to only 9% and in the average inflation - in that 10% - we are still belabouring with the policy rate itself being in the negative interest rate zone. As you well know, these interest rate hikes work into the economy in terms of demand destruction in their own time. It might take anything from three to six months to a year for the reality to hit home and contract demand. In the meanwhile, inflationary expectations can run away. Are you pretty much certain that the RBI will not have to act before July 29?

Rao: Probability is no, it may not be prompted to do anything on the monetary policy for July. Between July and October, we are looking at more on the liquidity side of adjustment because 50 bps is a strong enough hike on the back of 25 bps on repo rate.

This is the single largest dose after 2004. So, definitely it is going to act on correcting aggregate demand and there are no two ways about it. We would think that further rate action possibly would be on the reverse repo and the CRR.

Q: 11.42%, where do we go from here on the yield curve itself?

Narayan: Just imagine what the inflation print would have been if we had a bigger pass through in oil prices. The biggest worry for policymakers and the RBI is that this current level of oil is probably not sustainable on the medium-term. One angle is to try and pray that oil prices come down and they should come down logically to about USD 100/bbl. But as long as oil prices are here, aggregate demand has to be brought down noticeably. Since there is incomplete pass through, the local domestic demand for oil products is not coming down. The only way is to try and curb aggregate demand to the extent possible.

Coming back to your question, in terms of rates we are probably not done as yet as long as oil remains here and the oil remains where it is. There are worries on the fiscal front and yields have to move up.

Q: What do you think, in the run-up to July 29 itself, you would see yields beginning to challenge 9% or do you think the market might just wait out?

Narayan: Absolute levels actually don’t make sense in the current context. We have been fooled by absolute levels before in all-time highs at various levels. These are unchartered territories. So, as long as oil does not come down to USD 110 or so, we should be looking at higher rates and choking off aggregate demand. The pressures on the fisc will start to tell at some stage.

The Government of India bond yields are still holding up because there is probably not enough supply in the system. People are already positioned for this particular situation. But once the supply starts to hit eventually, which the fiscal deficit should do, the yields should move up.