Inflation clouds gather over Indian economy

What steel czar Lakshmi Niwas Mittal told the Financial Times on Friday served to underline the rising inflation fears of countries such as India in the financial year ahead.

The ArcelorMittal chief said the impending, and large, rise in the cost of iron ore would lead to new volatility in the steel industry, pushing up output prices.

Most economists say the impact on inflation could be substantial, considering that steel prices rose by over 9 per cent in the past year.

Barring cement, prices of most industrial commodities have gone up sharply.

While in some cases, such as nickel, prices have more than doubled, crude oil has surged about 75 per cent over the past year on rising demand from emerging economies such as China and India. Bullion is also on a high, with gold crossing the Rs 17,000-level on Friday.

In its Annual Monetary Policy Statement last month, RBI had said "the firming up of global commodity prices poses upside risks to inflation". The central bank's industrial outlook survey shows companies are increasingly regaining their pricing power in many sectors, and as the recovery gains momentum, the demand pressures are expected to accentuate.

Others agree. In its India Outlook for the new financial year, Dun & Bradstreet sees enough impending risks that would push the wholesale price index inflation to levels much higher than those in the financial year 2009-10.

Manufactured goods are expected to continue with price gains, driven primarily by higher international prices for many commodities that would raise input costs.

Looking forward, by the end of financial year 2010-11, manufactured goods' inflation would rise to 6.8 per cent from an expected 3.2 per cent in the previous year. Food prices would not add much to this, provided there is a normal monsoon this year. However, with energy price prospects biased towards further increase, D&B expects WPI inflation to average at 7 per cent in the current financial year.

Ajit Ranade, chief economist with Aditya Birla Group, said the volatility in commodity prices has gone up tremendously and monetary policy must have a prime place in inflation management.

In addition to the strong demand from China, he attributed the price surge to rampant speculation in the commodities space. "RBI has to take a pro-active stand on the issue to stay ahead of the curve through use of various tools at its disposal. Interest rate hike is just one of them. The commodity price surge impact on inflation is the biggest worry at this point," Ranade said.

Getting dearer
Commodity	30-Apr-09	30-Apr-10	(%) Change
Copper ($/tonne)	4515.00	7430.00	64.56
Zinc ($/tonne)	1408.00	2285.00	62.29
Aluminium ($/tonne)	1430.50	2255.00	57.64
Nickel ($/tonne)	11505.00	26300.00	128.60
Lead ($/tonne)	1355.00	2230.00	64.58
Gold ($/oz)	888.20	1179.20	32.76
MCX Rubber (100 kgs)	10200.00	16429.00	61.07
Crude ($/barrel)	49.10	85.99	75.13
Steel (Rs /tonne)*	46500.00	42500.00	9.41
Cement (Rs / 50 kg)	245 - 275	255-285	4.00
* Price of hot-rolled coil                           Source: BS Research Bureau

That inflation is a real worry due to industrial commodity price surge is also evident from a note issued by Goldman Sachs last month. The note did not agree with the view that high inflation was the result of high food prices alone. Among other things, it said core inflation was rising as the output gap has closed.

"Rising commodity prices - oil, steel, iron-ore, are all putting upward pressure on headline inflation," the note added.

Madan Sabnavis, chief economist at Care Ratings, agrees. Higher international metal prices would have a direct bearing on domestic prices, which would be reflected in higher raw material prices, he said.

Also, the domestic economy is showing initial symptoms of overheating as is seen in higher investment and higher industrial production, which would trigger demand-pull inflationary forces.

Unlike farm goods, where the government initiated steps such as allowing duty-free import of sugar and a ban on export of rice and wheat to cool down prices, its role in the industrial commodities space has been limited.

"While inflation was previously driven by supply-side factors, demand has also started coming into play. The only supply-side pressure is from agriculture and current forecasts say the monsoon will be normal. Since demand-side pressures are strengthening, monetary policy would have to be active and vigilant in order to keep inflation in check," said Crisil chief economist D K Joshi.

Most companies say the commodity price surge can exacerbate inflation expectations, put pressure on their profit margins, thus accentuating the risk of overall inflation rate moving upwards. They say they have little choice but to raise prices.

"As the demand for steel increases, raw material suppliers increase their price, thereby forcing steel producers to increase the price," said Anil Surekha, executive director finance at Ispat Industries.

The rise in the cost of raw material for steel making "is having a cascading effect on the input cost of products such as two wheelers," said Ravi Sood, chief financial officer, Hero Honda Motors, India's largest two-wheeler maker.

Economists say with companies operating at full capacity or nearing 100 per cent capacity utilisation, their pricing power would only increase. But companies dismiss suggestions that in a demand-constrained economy, they enjoy unlimited pricing power.

"This (increase in input cost) is putting pressure on our bottom line and we expect it to harden in the coming months as any price rise of our product will depend on market competitiveness," said Sood.

He is expecting the 10.5 million unit two-wheeler industry to grow at 11 per cent to 15 per cent in the current financial year, down from the 24 per cent growth it saw in the last year.

But there are still some who say the inflation fears may be overblown.

"Commodity pressures are under pressure because of the crisis in Greece and the spillover effect that it has had. I would be pretty bearish on commodities because Greece is just the tip of the iceberg and more problems are likely to emerge... That said, there might be some support for commodity prices given the high level of liquidity and there will be buyers at certain levels. There will be increased appetite for gold," said HDFC Bank's chief economist Abheek Barua.