The Wholesale Price Index (WPI) inflation – headline figure continued to hover around ~10% in May and Jun 2010 more or less stable at ~10% with a increase in Jun 2010. The WPI has been continuously on the rise since October 2009 easing a tad in May 2010. The main drivers of inflation continue to remain higher food prices (supply side constraints) followed by a recent increase witnessed in the manufacturing prices and fuel prices.
1. Food inflation clocked an average of 16% – 18% during Apr – Jun 2010, however, indications of a normal monsoon have slightly eased the supply situation and brought the figure down to around 12%-13% in early Jul 2010. The Government expects that a good monsoon will help increase agricultural output (to a great extent) and ease food inflation to single digits over the coming quarter.
2. However, lately fuel and manufacturing inflation figures have emerged as an area of concern with production costs witnessing a steady rise (owing to a robust growth in industrial output). Iron and Steel prices have risen substantially (~20%y/y) exerting pressure on capital intensive industries and automakers. Similarly, fuel prices have increased 13%-14%y/y.
3. Three factors a) tight market liquidity conditions – owing 3G mobile spectrum payments b) concerns over Europe’s debt crisis and c) increasing retail fuel prices are holding the RBI from undertaking an aggressive policy action.
Adding to the existing woes, a recent report about a dip in the bank deposit growth rate that grew 14% y/y in Jun 2010 compared to 22%y/y Jun 2009 has worsened the situation further. The dip mostly attributed to deposit withdrawals worth Rs.400 billion (US$9 billion) by Telecom companies to pay for 3G licences followed by loans undertaken to the tune of Rs.600 billion (US$13 billion). This temporarily drained Rs.1,000 billion (US$23 billion) out of the system indicating a minor liquidity crunch in the near term.
Over the coming months, credit demand is expected to outstrip deposit creation. Coupled with SLR investments and CRR requirements this gap will increase further. RBI and banks are proactively looking into the situation and are devising methods to avert the situation. Banks are increasing their deposit rates shortly to provide incentives to customers – in a move to increase deposit growth. RBI’ s move to increase repo and reverse repo rates by 25 bps and 50bps thereby making loans dearer with an aim to bring credit demand in line with deposit growth.
However, RBIs stance might affect the future credit growth and affect economic growth to some extent. Thus, a rising inflation rate continues to remain a key threat to the Indian economy.