Instead of writing on Tata Steel buying Corus, Hindalco’s buyout offer to Novelis and Vodaphone’s winning bid to purchase Li Ka-shing’s stake in Hutch Essar, I am behaving like a party pooper and focusing on inflation. As I write, WPI inflation is running at 6.58 per cent; and “in view of the paramount need to contain inflation expectations”, the RBI has yet again upped the cash reserve ratio of banks by half a percentage point to 6 per cent of net demand and term liabilities.

 

How serious is our current bout of inflation? What drives it? Can RBI’s monetary and credit tightening policies work? If not, what might?

 

For all the good news from corporate India, ours is a nation of over 500 million poor people. That being so, every government in India is hyper-sensitive about inflation. As Mr. P. Chidambaram once said to me, “At 6 per cent inflation, the government’s boat starts to rock; at over 8 per cent, there can be blood on the streets.” Having touched 6.58 per cent, India’s WPI inflation is serious enough.

 

Actually, matters are more serious than what three weeks of over 6 per cent suggest. The weekly WPI inflation number is a point-to-point estimate, which is prone to peaks and troughs due to the base effect. It is more sensible to examine a 13-week moving average (13-w MA), which knocks off the spikes and shows the underlying trend. The chart plots the WPI and its three key components: fuel, power and lubricants, primary products, and manufactures.

 

As the chart shows, the 13-w MA of primary product inflation has been rising since May 2006, and now stands at 8.4 per cent, with no signs of letting up. Incidentally, the point-to-point primary products inflation on 27 January was 10.7 per cent. Manufactures inflation has increased from 1.9 per cent in early May 2006 to 5.2 per cent today, and also on the rise — with the latest point-to-point estimate being 6.2 per cent. The saving grace has been fuel, power and lubricants, whose inflation has dropped significantly since July 2006, and stands at 4.1 per cent today, with the point-to-point at 3.7 per cent. Had crude reigned at $70 per barrel, we would have faced a WPI inflation of over 7.5 per cent.

 

The worst price rise has been that of pulses. Even in April 2006, pulse prices were up by 26 per cent on the basis of the 13-w MA. Today, inflation in pulses reigns at over 29 per cent! Cereals, too, have been on a rising inflationary trend, as have oilseeds.

 

If you carefully look at the data, you will be convinced as I am that our current WPI inflation is being driven largely by supply side factors. That being so, there is little that monetary policy can do, other than reduce money supply, hike interest rates and, in the process, possibly choke some of the growth impulse. When inflation is supply driven, it requires freeing up imports of primary products, sharply reducing tariffs on manufactures, and betting on a plentiful rabi crop. In any event, we are possibly looking at over 6 per cent inflation for another month or two.

 

But since RBI must be seen to be doing something, do it certainly will. So expect yet another round of credit tightening fairly soon — which will not really dampen WPI inflation but can harm growth.