Why RBI did not hike rates to contain inflation

Inflation continues its upward trajectory. The wholesale price wholesale price index (WPI), a measure of producer prices, for week-ended October 17 stood at 1.51% versus 1.21% in the previous week. Inflation for week-ended August 22 was revised to 0.17% as against the provisional figure of -0.21%.

‘Food prices driving inflation’

The threat of rising inflation as a result of stimulus measures and excess liquidity introduced by the government during the financial crisis has gained increased prominence of late. However, pure excess liquidity induced to boost growth is not the sole driver of inflation.

Reserve Bank of India Governor Duvvuri Subbarao points to rising food prices as also the driver. A woeful monsoon this year has resulted in food shortages across the country and rising food prices have played truant.

Thus, it is not just liquidity but also supply-side pressure that is putting pressure on inflation. In its monetary policy review earlier this week, the RBI — amid calls to tame inflation — chose not to tighten its stance by hiking key rates like repo and reverse repo.

A hike in rates would not have been helpful in containing inflation, Subbarao felt. “What would have been the benefit of tightening at this point in time? It would not have helped us to rein in inflation because it is driven by food prices,” he told CNBC-TV18 in an interview.

In its monetary policy, the RBI raised its forecast for inflation by March 2010 to 6.5%, up from its earlier estimate of 5%.

Inflation forecast not on new series

The government recently changed its base year used to calculate inflation from 1993 to 2004 and may soon start publishing inflation data on a monthly basis instead of every week, as is the practice now.

However, the RBI’s March target is based on the current series, the RBI governor said. ”The new WPI series is not used to arrive at the inflation forecast. We will recalibrate our forecast after the new series comes out,” he said, adding that inflation may go up till December before plateauing out.