Comfort but no confidence as yet:
The ease (and down-trend) in core and headline inflation is great comfort with confirmation that the worst is behind, thus removing the fear (and risk) of rate hike which RBI has not ruled out in its earlier guidance. What needed now is the confidence on sustainability of inflation at ideal comfort (and tolerance) zone of 2-4% in WPI and 4-6% in CPI, seen as good balance for interest and exchange rate dynamics!
The current ease in retail CPI inflation below 6% and wholesale WPI inflation sub 2% is seen to be driven by base effect and sharp reversal in imported commodity prices. The permanent remedy from removal of supply-side bottlenecks and addressing structural woes around twin deficits is not yet seen. Combining these two factors, there may be upward pressure on headline inflation into medium/long term from lower base, limited downside pressure on commodities, accelerated demand from growth pick-up not being met with desired supply capacity expansion and no clear strategy on fiscal prudence other than disinvestment. There is also need for RBI to retain interest rate high to ring-fence Rupee exchange rate from external sharks. All taken, it does make sense for RBI to stay firm on interest rates and tight on liquidity for now.
Over all, while there is relief on inflation that worst is behind and comfort that the expectation is positive, there is no confidence as yet on long term sustainability when tailwind benefits stay diluted and headwind impact emerge as risk, going forward! It is good to leave Dr.Rajan alone (along with his able economic/technical advisory team) to have a balanced approach with target at long term stability!
Moses Harding
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