India's headline inflation rate, based on the Wholesale Price Index, fell to a 71-week low of 3.79% for the week to Aug 25. The inflation rate was 3.94% a week ago and 5.27% a year earlier, the commerce and industry ministry said today. The fall is mainly on account of statistical impact of a high base. The high base effect is likely to push headline inflation rate further down in the coming weeks. The latest inflation rate is below consensus estimates. According to a NewsWire18 poll of 16 analysts, the inflation rate for the week was seen at 3.89%.

In the week to Aug 25, index for all commodities was 213.6, unchanged from a week ago. In the corresponding week last year, the index had risen 0.1% to 205.8.

The headline inflation has eased to the current level after hitting a two-year-high of 6.69% late January, primarily on high base. The Reserve Bank of India is targeting an inflation rate of close to 5.0% for the current financial year to March.

For 2006-07, the year-end inflation rate was 5.94%--above the central bank's target of 5.0-5.5%.

The government and the RBI have taken a series of monetary and fiscal measures in the recent months to stem inflation, including raising interest rates and cutting duties.

In the quarterly review of the annual policy on Jul 31, RBI said the fear of high inflation remained despite the recent decline.

In the week to Aug 25, the WPI for main commodity groups was as follows:

--Primary articles at 224.5, down 0.1% from 224.7 a week ago; food articles 223.3 down 0.2%; non-food articles 209.9, up 0.1% on week. Primary articles mainly comprise farm goods, and have 22% weight in WPI.

--Fuel, power, light and lubricants was at 322.1, unchanged from a week ago. The group has 14.2% weight in the WPI.

--Manufactured products--with 63.7% WPI weight--were at 185.6, unchanged from a week earlier. All numbers are provisional estimates, and may be revised after eight weeks.

FINAL INDEX
Final index for all commodities for the week to Jun 30 was 212.8 compared with the provisional estimate of 212.5. Consequently, the final inflation rate for the week was 4.42% compared with the provisional estimate of 4.27%.

India's headline inflation rate, based on the Wholesale Price Index, rose to 4.10% for the week to Aug 11 from 4.05% a week earlier. The rise is on account of increase in prices of food articles, particularly vegetables.

In the year-ago period, the inflation rate was 5.07%. The latest inflation rate is above consensus estimates. This rate was seen unchanged from the previous week at 4.05%.In the week to Aug 11, index for all commodities was 213.4, up 0.1% from 213.1 a week earlier. In the corresponding week last year, the index had risen 0.1% to 205.0.

Prices of vegetables increased 5.1% during the week. The headline inflation has eased to the current level after hitting a two-year-high of 6.69% late January, primarily on high base.

The Reserve Bank of India is targeting an inflation rate of close to 5.0% for the current financial year to March. For 2006-07, the year-end inflation rate was 5.94% above the central bank's target of 5.0-5.5%. The government and the RBI have taken a series of monetary and fiscal measures in recent months to stem inflation, including raising interest rates and cutting duties. In the quarterly review of the annual policy on Jul 31, RBI said the fear of high inflation remained despite the decline in recent weeks.

The RBI raised banks' cash reserve ratio by 50 basis points to 7%, and removed the Rs 30 billion cap on reverse repo in a bid to suck out excess liquidity. In the week to Aug 11, the WPI for main commodity groups was as follows

Primary articles at 223.5, up 0.4% from 222.5 a week ago, food articles 221.8, up 0.7%, non-food articles 210, down 0.1% on week. Primary articles mainly comprise farm goods, and have 22% weight in WPI.

Fuel, power, light and lubricants at 322.1, unchanged from a week ago. The group has 14.2% weight in the WPI.

Manufactured products with 63.7% WPI weight was at 185.7, up 0.1% from 185.6 a week earlier.

FINAL INDEX

Final index for all commodities for the week to Jun 16 was 211.9 compared with the provisional estimate of 211.7. Consequently, the final inflation rate for the week was 4.13% compared with the provisional estimate of 4.03%.

India's headline inflation rate is based on the Wholesale Price. Index; fell to 4.05% for the week to Aug 4 from 4.45% a week earlier, the commerce and industry ministry said today. The fall is on account of decrease in prices of food articles and statistical impact of a high base. In the year-ago period, the inflation rate was 5.08%. The latest inflation rate is below consensus estimates.

According to a NewsWire18 poll of 15 analysts, inflation was seen down at 4.35%. In the week to Aug 4, index for all commodities was 213.1, down 0.1% from 213.4 a week earlier. In the corresponding week last year, the index had risen 0.2% to 204.8.

India's headline inflation had hit a two-year-high of 6.69% late January, but has since eased primarily due to effect of a high base.

The Reserve Bank of India is targeting an inflation rate of close to 5.0% for the current financial year to March. For 2006-07, the year-end inflation rate was 5.94%--above the central bank's target of 5.0-5.5%.

The government and the RBI have taken a series of monetary and fiscal measures in recent months to stem inflation, including raising interest rates, cutting duties, reducing auto fuel prices, and banning futures trade in commodities.

In the quarterly review of the annual policy on Jul 31, RBI said the fear of high inflation remained despite a fall seen in the last few months and reiterated that inflation check was still the central bank's chief aim. The RBI raised banks' cash reserve ratio by 50 basis points to 7%, and removed the Rs 30 billion cap on reverse REPO in a bid to suck out excess liquidity. It feared a surfeit of liquidity in the banking system could have pushed down interest rates and stoked inflationary pressure.

Earlier this month, the government said external commercial borrowing of over $ 20 million has to be compulsorily spent overseas. The move is aimed at moderating capital flows into India.

In the week to Aug 4, the WPI for main commodity groups was as follows:

--Primary articles at 222.5, down 0.4% from 223.4 a week ago; food articles 220.3, down 0.7%; non-food articles 210.3, up 0.3% on week. Primary articles mainly comprise farm goods, and have 22% weight in WPI.

--Fuel, power, light and lubricants at 322.1, up 0.1% from last week's level of 321.9. The group has 14.2% weight in the WPI.

--Manufactured products with 63.7% WPI weight were at 185.6, down 0.1% from 185.7 a week earlier.

All numbers are provisional estimates, and may be revised after eight
weeks.

FINAL INDEX

Final index for all commodities for the week to Jun 9 was 211.8, unchanged from the provisional estimate. The final inflation rate for the week was 4.28%.

Core inflation should edge down a bit over the next year and a half, as inflation expectations remain contained, energy prices flatten out and pressures from the labor and product market diminish, Federal Reserve board chairman Ben Bernanke said Wednesday.

"Core inflation should edge a bit lower, on net, over the remainder of this year and next year," Bernanke said in prepared testimony to the House Financial Services Committee. "If energy prices level off as currently anticipated, overall inflation should slow to a pace close to that of core inflation in coming quarters," Bernanke said.

On growth, the Fed chairman said the economy should expand at a "moderate pace" over the second half of 2007, and "strengthen a bit" next year. Bernanke said the central bank remains on alert that this soft-landing scenario will not pan out. He stressed that there are risks in both directions -- of slower growth from the ongoing housing correction and of higher inflation from a possible sharp rise in energy and commodity prices.

Bernanke did not ignore headline inflation in his testimony, but said that core inflation, which strips away volatile food and energy prices, "may be a better gauge than overall inflation of underlying inflation trends." His remarks suggest vigilance but not panic on the outlook.

"There is nothing in the prepared testimony designed to shake market expectations of little if any change to Fed policy over the medium term," said Josh Shapiro, chief U.S. economist at MFR Inc., in a note to clients. Ian Shepherdson, chief U.S. economist at High Frequency Economics, said Bernanke's testimony "is little more than an expansion of the views set out in recent FOMC statements; there is no signal of any change in the Fed's core views."

"The Fed is sticking to their guns. They still see a pretty good economy going forward," said Ethan Harris, chief economist at Lehman Brothers, in a television interview after Bernanke had concluded his testimony.
Bernanke's remarks had little impact on the stock market.

Treasury prices rose, sending yields lower, as investors cheered Bernanke's comments that core inflation should edge down. Read Bond Report. The dollar dropped as the prospects for any rate hike receded. Read Currency report. Bernanke's "prepared comments [were] less hawkish than the market was anticipating," said Kathy Lien, chief strategist at DailyFX.com.

Bernanke said that the headline price index for personal consumption expenditures inflation rate is at 4.4% annual rate over the first five months of the year. This pace, if maintained "would clearly be inconsistent with the objective of price stability." Recent readings on core inflation "have been favorable," he said, but there is considerable noise in the data and some of the improvement "could also be the result of transitory influences."

Bernanke's comments fit squarely in the most recent Fed policy statement that "a sustained moderation in inflation pressures" has yet to be "convincingly demonstrated." The Fed has kept the federal funds target rate at 5.25% for more than a year.

Bernanke made little news in his questions and answers with members of the House panel. Many members focused on rising income inequality. Bernanke said the trend of income inequality has been worsening for 30 years and the Fed's role was to keep the economy strong and stable. Education reform was another key, he said. Bernanke warned that the Fed is watching inflation expectations closely.

BSE's banking sector index Bankex had spurted 153.28 points, or 1.92%, to 8,143.76 at 15:25 IST on hopes that interest rates may soften due to lower inflation.

The current level is an all-time high for the Bankex. It had hit a low of 8,019.66 so far during the day. The Bankex had touched a 52-week low of 4,032.39 on 19 July 2006.

State Bank of India advanced 3.21% to Rs 1580, ICICI Bank 1.64% to Rs 966.25, HDFC Bank 0.34% to Rs 1150, Bank of India 0.26% to Rs 228.20, Punjab National Bank 2.55% to Rs 541.80.

ICICI Bank, State Bank of India and HDFC bank have weightages of 40.36%, 17.12% and 13.83%, respectively, in the Bankex.

Bank shares rose today on renewed buying on expectation that nterest rates may soften due to lower inflation. Lower interest rate would lead to higher demand of funds from consumers. Data released late last week showed that the inflation declined to a 14-month low of 4.03% in the week ended 16 June 2007.

The Bankex had risen 4.76% from 7479.15 on 18 June 2007 to 7835.34 on 22 June 2007, following strong response to the follow-on public offer (FPO) of ICICI Bank that was open for subscription for four days between 19 to 22 June 2007.

Earlier, the Bankex had dipped from 7,512.09 on 7 June 2007 to 7,368.69 on 13 June 2007. From that low, it had gained 8.43% to 7990.48 on 2 July 2007.

The Bankex moved up 4.01% over the last one month to 2 July 2007 compared to the Sensex’s return of 0.64%. The index rose 29.24% in past three months compared with the Sensex’s rise of 16.16%.

Inflation rate fell more than expected to a 14-month low in mid-June, but analysts said on Friday that firm manufactured product prices and data revisions meant the Reserve Bank of India had no room to relax policy now.

Separate data showed the current account balance swung into surplus in the March quarter from a deficit at the end of 2006, helped by Indians overseas sending money home.

The widely tracked wholesale price index rose 4.03 percent in the 12 months to June 16, slowing from an annual rise of 4.28 percent a week earlier and well below a two-year high of 6.69 percent in late January, data showed.

It was lower than a Reuters poll estimate of 4.13 percent.

But analysts said that firm manufactured product prices and data revisions meant the RBI had no room to relax policy now.

"The manufacturing inflation, or core inflation, has still not come off," said Harish Menon, economist at ING Vysya Bank.

"The RBI should pause rather than react to these positive numbers. If the market is looking to go into an easy monetary stance based on these numbers, they would be disappointed."

The annual inflation rate for April 21 was revised up to 6.07 percent from 5.77 percent, with the index for that week revised up to 211.5 points - just 2 points below the preliminary index level as at June 16.

Speaking after the data, RBI governor Yaga Venugopal Reddy reiterated the central bank's aim was to contain inflation to 5 percent in the fiscal year that began in April, and lower it to 4.0 to 4.5 percent in the medium term.

The RBI has raised interest rates five times in the past year, the last time at the end of March, but could now hold its fire when it next reviews policy on July 31 with inflation below its comfort zone of 5 percent.

Finance Minister Palaniappan Chidambaram has said that policy tightening and currency strength had helped moderate inflation, and more rate rises may not be needed if the trend continued.

In its latest forecast, the weather office said monsoon rains in July -- the most crucial month for farm output-- were expected to be 95 percent of the long period average. Analysts say good monsoon rains would result in better crops which in turn could help ease supply pressures and inflation.

The Indian economy, Asia's third-largest, grew 9.4 percent in the fiscal year that ended in March, its highest rate in 18 years and second only to China among major economies.

CURRENT ACCOUNT SURPLUS

The government said its fiscal deficit for April and May, the first two months of the 2007/08 fiscal year, was 621.35 billion rupees ($15.3 billion), or 41.2 percent of the full-year target of 1.51 trillion rupees.

Separate data from the RBI showed the current account swung to surplus of $2.56 billion in the March quarter from a revised deficit of $2.78 billion in the December quarter.

For the 2006/07 fiscal year, India posted a current account deficit of $9.61 billion. While that was wider in dollar terms from a $9.19 billion deficit in 2005/06, the deficit held steady at 1.1 percent as a percentage of gross domestic product.

The balance of payments surplus rose to $20.45 billion in the March quarter from a revised surplus of $7.51 billion in the December quarter. External debt rose by $12.3 billion in the quarter to $155.0 billion at the end of March

Inflation declined to around 14-month low of 4.03% for the week ended June 16, as essential food items and some manufactured products turned cheaper, easing pressure on RBI to further increase interest rates. The market expected 4.13%.

The wholesale prices-based inflation rate fell for the 10th consecutive week from the previous week level of 4.28%. Inflation also fell due to some base effect as it stood at high of 5.5% during the corresponding week
last year.

Earlier in the week, Finance Minister P Chidambaram had said in London that central bank tight monetary policy and rupee appreciation had helped to moderate inflation and more rate rises may not be needed if the trend continues.

Chidambaram wants to contain inflation without hurting economic growth, which he says is the antidote to poverty. India's central bank has raised benchmark rates nine times since October 2004 to damp consumer demand and may now rely on the delayed effect of raising borrowing costs to a five-year high to rein in inflation.

A pause in the Reserve Bank of India's policy of raising interest rates will help bolster economic growth. India's industrial production grew 13.6% in April, the government said on June 12. India's economy has averaged 8.6% growth since 2003, the second-fastest after China among the major economies, causing demand for manufactured and farm goods to outstrip supply and stoking prices.

Inflation is at its lowest since the week ending April 29 last year, when the rate was at 3.9%, according to data compiled by Bloomberg. It accelerated to 4.37% in the following week. To check prices of food grains, which have risen at almost twice the pace of manufactured product costs in the past year, the government removed the import duty on lentils in June 2006, and on wheat in September.

Inflation stayed unchanged at the previous week’s level of 6.09% during the week ended 14 April, above the RBI’s mandate of 5% for the current fiscal.

The high level of inflation could be gauged from the fact that it was just 3.7% during the corresponding week of the last fiscal.

Surprisingly, prices of vegetables which shot up over 23% during the previous week, contributing most to inflation, declined by 5% in the week under review.

This is the first inflation data released after the RBI came out with its annual monetary policy, in which it projected inflation to be 4-4.5% in the medium term. RBI governor Y V Reddy has said 5% inflation rate in 2007-08 was the “self-imposed mandate” for the bank.

RBI had projected inflation at 5-5.5 per cent for 2006-07, which was belied by figures in later part of the year though average inflation was within its tolerance level.

However, the figures for the week during which RBI released its credit policy would be known two weeks after because of the time lag.

If inflation continue to remain above 6%, RBI might have to take further monetary tightening measures, which it refrained from in its annual policy, analysts said.

Besides vegetables, prices of fruits, urad, coconut oil, naphtha, brass sheets and strips pulled down inflation. But this was offset by price rise in non-vegetarian food, gram, groundnut oil, cotton seed oil and ferro silicon. Prices of other products moved in a narrow range.

‘Long on language and short on measures’ is how the Governor of RBI (the Reserve Bank of India) Dr Y.V. Reddy described the Annual Policy Statement for 2007-08, announced on Tuesday. The ‘short’ part of the cryptic phrase may interest experts who generally like to analyse and dissect the policy to pick holes in the Guv’s measures. For the rest of us, who are ready for a long haul, a patient ploughing through, of the 73-page, 30,000-word, 2-lakh-character output from the RBI can unearth many examples of linguistic acrobatics.

Let’s begin on a note of ‘overall optimism’ that the latest statistical estimates ‘have vindicated’, in tune perhaps with ‘successive upward revisions in growth projections by various agencies’. Explains Dr Reddy that “while the momentum of economic activity and the turnaround in the interest rate cycle resulted in an increase of 17.7 per cent in interest payments in contrast to the decline recorded in the preceding two years, higher growth in sales and gross profits in relation to interest payments ensured a lower interest burden (i.e., interest payments relative to gross profits) and interest cost to sales…”

Before you slow down from the whirr the ‘turnaround’ caused, add fizz to your fluffiness by knowing that “the acceleration in real activity propelled a sizeable expansion in monetary and banking aggregates.” Are these bodings for good or bad, you may be pardoned for wondering, because such uncertainty is possibly a widespread phenomenon. For, how else would you explain why ‘business confidence surveys conducted by other agencies present a somewhat mixed picture’? Concedes Dr Reddy that ‘globalisation has brought in its train considerable fuzziness in reading underlying macroeconomic and financial developments, obscuring signals from financial prices and clouding the monetary authority’s gauge of the performance of the real economy.’

Inflation inflection

Though the Finance Minister recently said that the RBI has no control over prices of items like tomato, the credit policy had a lot to say about inflation. “It is important to undertake a careful assessment of the manner in which inflation is evolving,” observed the Guv, considering the many ‘upward pressures on headline inflation’. Globally, ‘monetary policy authorities are inclined to continue to regard inflation as a major global risk and are vigilant about threats to inflation expectations,’ he informed us. And he fretted, “There is considerable difficulty faced by monetary authorities across the world in detecting and measuring inflation, especially inflation expectations.”

Is there a foreign hand to the price of pyaaj and aalu? May be, yes, since ‘domestic prices are largely mirroring global trends’ and ‘export demand is emerging as a significant determinant of inflation’. It may not elevate your mood to know that ‘elevated prices of primary food articles, which have a higher weightage in the CPI basket relative to the WPI, have been the main drivers of consumer prices and the major cause of the divergence between inflation rates based on the CPI and the WPI.’ Also, “In conjunction with emerging strains on capacity, elevated asset prices and the surging demand for bank credit, the rising prices of manufactures constitute the demand pressures on inflation.”

The Guv, therefore, states grimly, “Currently ruling above indicative projections in terms of wholesale prices and at unconscionable levels in terms of consumer prices, inflation represents the key downside risk to the evolving macroeconomic outlook.” Yet, he is determined ‘to continue to demonstrate that inflation beyond the tolerance threshold of the Reserve Bank is unacceptable and that the resolve to ensure price stability is always backed by timely and appropriate policy responses’.

Apart from that resolve, there are two other factors to draw comfort from. One, we aren’t alone. ‘High expansion in money supply has become a worldwide phenomenon, resulting in its progressive de-emphasis in monetary analysis.’ All over the world, ‘headline inflation has picked up in the wake of increase in commodity prices, and core inflation has also generally remained firm.’ Thankfully, however, ‘most Asian EMEs (AEMEs) have recorded strong growth with reasonably well-anchored inflation expectations’.

And the second factor is that the magicians on the Mint Street are deploying ‘a combination of fiscal, external and supply management policies supplemented and complemented by ongoing monetary measures,’ for the effective containment of inflation, ‘drawing from the analysis of inflation dynamics’. The policy stance was underpinned by a commitment to respond swiftly with all possible measures to developments impinging on inflation expectations and the growth momentum, assures the Guv. As a result, “Despite sizeable movements in major international currencies, the pass-through to domestic inflation has been muted.”

Liquidity overhangIf it had missed you that ‘during the year, the financial markets shifted from conditions of easy liquidity to occasional spells of tightness necessitating injection of liquidity through the LAF (not learners’ air force, but Liquidity Adjustment Facility), better look up. Do you see ‘the total overhang of liquidity under the LAF, the Market Stabilisation Scheme (MSS) and surplus cash balances of the Central Government’?

Ever wondered what happens ‘in an environment of above-trend growth in the world economy and abundant liquidity’? Investors are ‘prepared to purchase risky assets at relatively high prices’. Dangerously, ‘The perceived risks arising mainly out of the prospects of withdrawal of liquidity and global imbalances do not appear to be reflected in the pricing of risks.’ Not a happy situation for the RBI, because “monitoring risks has become very difficult for the regulators, due to emergence of large conglomerates, sophisticated market instruments such as derivatives, presence of players like hedge funds and shifting of financial risks from well-regulated to weakly or less regulated segments.”

Accentuating the unease is the worry ‘that a sharp reversal of carry trades could precipitate liquidity stress and affect near-term prospects of emerging market economies, should there occur a generalised search for safe haven’. Dark fears would turn darker if you were to discover that “the overnight rates in the market repo and collateralised borrowing and lending obligations (CBLO) segments, which were around the lower end of the LAF rate corridor till May 2006, started hardening in June in response to underlying liquidity conditions…”

Bankers’ English

You can bank on the credit policy’s finance-speak to enrich your phrase bank. Try, for instance, mouthing, ‘With some volatility in the second half amidst heightened activity…volumes increased steadily and interest rates firmed up in all segments,’ and you can be assured of heightened attention from all disoriented directions. Unrelenting, unleash more, notwithstanding ‘the onset of a durable pick-up in aggregate spending easing.’

Your audience may experience ‘impulses for expansion’ juxtaposed with ‘episodes of tightness,’ when treated with ‘an inversion of the yield curve and a narrowing of yield spreads,’ or ‘upsurge of demand pressures… with a cyclical component’, but before convulsions set in, offer the hapless happy dreams of ‘sustained buoyancy…and containment of growth’, anchored ‘financial stability,’ ‘a concerted and calibrated move to rebalance the regulatory and supervisory role’ coupled with ‘a broad-based, participative and consultative approach,’ and ‘operational flexibility and…greater manoeuvrability in monetary management.’

Din into their ears that ‘lumpiness and gestation’ are ‘inevitable in building production capacities’, and that they should not ‘delay the supply response to the impetus from aggregate demand and realisation of the capacity expansion’. Cajole everybody, saying that ‘time paths for decision making’ are ‘not formally constrained,’ and that ‘sustained strength and vibrancy’ reflect, as you might have guessed, ‘robust macroeconomic fundamentals.’

Urge those around you to shrug off ‘initial expectations of a deceleration,’ though ‘flows do have the potential of reversing rapidly in response to the withdrawal of monetary accommodation now taking place.’ With ‘risk appetite… increased in search of higher yields,’ the afflicted may ask for more, as do ‘institutional investors’ who are not put off by ‘compression of spreads…which cannot be fully justified by improved fundamentals.’ Watch out: “In the event of a loss of risk appetite and consequent unwinding of leveraged positions, there could be serious adverse effects…”

The Guv sombrely declares that ‘the importance of communication has received significant emphasis in the recent period’ and so ‘the RBI has been reaching out in order to encompass the widest sections of society in the financial system through the spread of financial education so as to encourage a more informed evaluation of its policies…’ Noble intentions, you’d agree.

The Reserve Bank of India, or RBI announced its annual credit policy on Tuesday. It has kept all the policy rates - the CRR, repo as well as the reverse repo rates unchanged.

The apex bank's move did not surprise the markets. It left all key policy rates unchanged and maintained a status quo on its monetary policy stance.

Ajay Shah, Economist with IGIDR, comes back with the opinion that it is a given that monetary policy works with a lag. If however the latest available data on inflation is showing that inflation is roughly at 7.5% and if the two policy rates are at 6% and 7.5%, then the two real rates would be 0% and minus 1.5%.

He doesn't think this stance of monetary policy will slow down inflation. There is usually, a long lag between real rates slowing down the business cycle, which he doesn't see happening at this point. The story is far from over and there may be problems in store on inflation.

The first reaction from the markets has been one of relief. On whether this keeps the door open for an inter-policy rate-hike, Samiran Chakrabarty, Economist wih ICICI Bank, believes that the RBI seems to be much less hawkish than what it has been talking in the last few policies.

He welcomes the step that the RBI is recognizing the lagged impact of policy responses and that augurs well for the growth outlook. But eyes need to be kept open towards the inflation outlook and watch how it pans out. That will be the clue to an intermitting rate hike.

Could there be a reason for inflation to fly off the handle, simply because rates have not been hiked? On this Ajay Shah is of the opinion that he doesn't want to overplay the argument, as there cannot be a real rate of, roughly, zero. Secondly, there are the CRR hikes and exchange rate appreciation, which will benefit the inflationary data. There is also a non-transparent piece of monetary policy, which is, how the RBI trades on the currency markets.

Becasue, how they trade on the currency market affects local interest rates. It is a non-transparent tool of monetary policy, which can be used in coming days.

He says one does not really know how things are going to pan out, and that the situation is genuinely worrisome. He does not share the comfort of other people who seem to think that inflation is tolerable and low interest rates should sustain growth; that is a false perspective, because there is no trade-off between inflation and growth. The inflationary spiral will fundamentally contaminate growth.

While, Samiran Chakrabarty thinks that the policy has kept everyone guessing. If that is the case, then inflation-fighting seems to be the predominant stance and policy response, going forward, is likely to have a tightening bias. It's difficult to quantify the number of rate hikes expected at this point, but inflation target being reduced a tiny bit to 5% is worrisome.

So, it has to come to below 5% for RBI to become comfortable on the inflation front. That has still some way to go, he thinks.

The inflation fighters in the Reserve Bank of India have administered
the expected - and stronger than expected - countermeasures to fight
inflation. Inflation has been running at above 6 per cent measured by
the wholesale price index and is above the comfort level adjudged by
the RBI and the Centre.

The decisions announced by the RBI include a rise in repo rates (the
rates at which banks borrow from the RBI), a rise in cash reserve
ratio and a reduction in rate of interest on cash deposited by banks
with RBI. The signals are intended to spur banks to raise lending
rates and to reduce the amount of credit disbursed. The RBI's measures
are expected to suck out a substantial sum from the banks. In effect,
while the economy is booming and the credit needs grow, the central
bank is tightening the availability of credit.

A cancer specialist does not or should not care too much for the
comfort of the patient when he or she prescribes chemotherapy.
Similarly, has the RBI proved too enthusiastic at prescribing severe
chemotherapy to starve out the tumour that is inflation? It may weaken
the healthy cells as well. The shocked market analysts and economists
have been at pains to analyse the various implications of the central
bank's action and the possible alternatives.

The markets have signalled their resounding reaction by a sharp fall
in the Sensex by nearly 500 points. The impact on economic growth is
also likely to be sharp, judging by effects of similar therapy applied
with disastrous effect in the mid-1990s.

Did the RBI have an alternative to its `shock-and-awe' tactics? Could
it not have waited for the crop harvests to come in and the effect of
seasonal adjustments to play themselves out? It is admitted by all and
sundry that the rate hikes will take some time to act on inflation. By
then, the eagerly awaited wheat harvest would have come in and the
effects of supply responses would mask the direct impact of RBI's
actions.

It would, however, reduce the level of investment activity in the
economy, particularly in the infrastructure sector. Big corporates may
ask for, and get, access to external commercial borrowing, but not so
favoured are the bulk of small and medium entrepreneurs. Governments
will also face the risk of rising interest costs. Housing activity
will suffer an impact because most loanees are on floating rates and
will face increased equated instalments. Perhaps, an effect desired by
the RBI - a slowdown in housing expansion - will come to pass.

Radical alternative

In a seminal interaction in a recent media debate, Dr Ila Patnaik has
pointed out that the present policy problem demands a rethink of the
framework of the monetary policy-makers. Dr Patnaik says the RBI
pursues conflicting objectives in its currency interactions (which
involve purchase of dollars for rupees) and its contractionary stance,
as evidenced by recent measures.

The RBI buys dollars from banks and exporters, partly to prevent the
dollars from flooding the market and depressing the dollar -
indirectly raising the rupee. In other words, the central bank's
interactions have a desirable objective - to keep the rupee devalued -
which will make India's exports more competitive, but they increase
liquidity.

To combat this, the RBI does what it calls "sterilisation" - it sucks
out the rupees it pays out for dollars through sale of sterilisation
bonds. It then sells these bonds to banks. Dr Patnaik points out that
there has not been much success in such sterilisation attempts in
India. The central bank's attempt to offload Government bonds on banks
has not been too successful inasmuch as the banks sell the bonds and
get rupees instead.

Dr Patnaik contrasts this with the successful experience of China,
where the state-owned banks strictly abide by the central bank's
dictates and absorb the sterilisation bonds. That discipline is
lacking in India. The net effect is that the RBI has to resort to
indirect methods of sterilisation, such as raising interest rates and
raising CRR to contract liquidity. This makes India more attractive
for foreign capital flows that seek better returns and a vicious cycle
follows. RBI has to buy more foreign currency and sterilize. The cycle
becomes worse.

Dr Patnaik suggests a radical alternative, viz. that RBI should
rethink its currency policy, which results in flooding the markets
with rupees. She admits that cessation from direct intervention in the
foreign currency markets will lead to rupee appreciation, which may
hurt India's exports. To this, she has an answer. The real effective
exchange rate is nominal exchange rate minus inflation. Higher
inflation mops up the competitive advantage of a weaker rupee.

In Dr Patnaik's opinion, the RBI should explore the possibility of a
different policy mix, which leads to the central bank having a
calibrated control over money supply as well as exchange rate. An
appreciating rupee may also lead to lower inflation.

Dr Patnaik further points out that "while inflation is relatively
high, at 6.5 per cent, it does not yet appear to run away completely
out of control. In contrast, monetary policy, with call money rates
going above 70 per cent, seems to have been lost control of. Neither
is the policy able to provide stable conditions in financial markets,
nor is it able to control inflation".

Transparency

She explains this further, pointing out that "money gets created in
two ways". First, when the RBI buys a dollar with rupees, it creates
rupees. Second, when the RBI lends to the government, it creates
rupees". For many years now, no rupees have been lent to the
government by the central bank. The bulk of money circulating in the
economy increases mainly by dollar purchases by the Bank. It is dollar
purchases that created the bulk of liquidity between April 2006 and
January 2007. The RBI has added liquidity through the sale of the
order of Rs 56,000 crore.

Dr Patnaik is an experienced economist and reputed analyst of monetary
policy. She pleads for greater transparency in the RBI's sterilisation
operations. Basically, Dr Patnaik's alternative policy mix is a
holistic one with a focus on inflation control without too much
emphasis on interest rates. She believes that this change of emphasis
will enable the central bank to avoid a confusion of objectives and
control inflation while maintaining adequate growth. By all means, let
the RBI's fight against inflation continue. But there should be a
clear paradigm to adopt. The US Fed Reserve, which is the RBI's model,
does not have resort to CRR. The control is through the price of money
- that is, interest rate, and not the quantity.

The Fed does not sequester resources of the banking system by raising
CRR for it has zero CRR. Even if the Fed's monetarist model is
followed, one has to allow borrowers to get credit at least at a
price. Both quantity and price cannot be controlled at the same time,
which is what the RBI is doing.