Inflation at 2-yr high, heat on interest rate

There was a sharp rise in the prices of primary products by 9.3% compared to prices in the corresponding week last year. This spiked the overall index despite moderation in fuel prices which rose merely 3.6% year-on-year.

Since Oil prices are based on global factors and commodity prices of primary articles get affected by short term factors and are often highly volatile, many countries look at “core inflation.” Core inflation basically means excluding the prices of these two highly volatile components from the inflation figures.

Even if that’s done, inflation based on prices of manufactured goods, a measure of core inflation, rose by 5.9%.

Former RBI Governor and chief economic advisor to the Prime Minister C Rangarajan said, “The trend was in the direction of inflation accelerating. If inflation rises beyond 5.5%, it’s a matter of concern and can cause problems in the exchange rate.”

Concerns have been expressed that the Indian economy, with its high growth rate and rising inflation rate, high real-estate prices and rising salaries, is overheating. Ratings agency Moody’s said as much this week adding that capacity constraints could prevent annual growth of 9% from being sustained.

The difficult question is what to do about the “overheating” if it is indeed happening. While on the one hand, raising interest rates would help contain inflation, on the other, it would slow down growth.

However, despite the danger of being accused of spoiling the party, keeping rising inflation in mind, in recent months the RBI has taken a number of steps to tighten monetary policy.

Interest rates — the repo rate and the reverse repo rate — have been raised and the Cash Reserve Ratio has been hiked.

This would suck liquidity out of the banking system and reduce the availability of credit making it more expensive to borrow. But the latest inflation numbers may not necessarily...