Inflation is less likely to come within the prescribed limits

- Two main challenges facing the Reserve Bank: controlling inflation and keeping the rupee stable

Retail inflation of 7 percent in August positively surprised most analysts. Since price hikes are broad-based, rates are likely to remain high in the coming months as well. For example, staple food prices rose by 9.57 percent in August, while vegetable prices rose by over 13 percent. The overall inflation based on food prices has been 7.62 percent.

Food prices may remain under pressure, with core inflation remaining high due to low rainfall in many parts of the country. The government last week imposed restrictions on rice exports in an attempt to control prices. However, estimates suggest that uneven rainfall will not have much impact on production but may still affect prices in the coming months.

The government has taken several measures during the past months to curb inflationary pressures. Not only has he imposed restrictions on wheat exports in view of reduced production due to hot winds in many parts of the country, but he has also signaled oil marketing companies to bear the brunt of rising food oil prices in international markets. Now the government is giving Rs 20,000 crore to oil marketing companies to compensate for the rise in oil prices in the international market.

Some of these measures may have helped curb inflation, but they have led to market anomalies that will show their effects in the long run. For example, even though the price of crude oil in the international markets has fallen by almost 25 percent in the last three months, it has not had any impact on the prices of oil at the petrol pump. There are chances that the companies will recover their losses first and only then let the profits reach the consumers. It is an opaque process and affects consumers.

The emerging macroeconomic situation has made the situation difficult for the Reserve Bank of India. Inflation has been above the limit for eight consecutive months and, as per estimates, it may not come within the target range in the current financial year.

In such a scenario, the Reserve Bank will first have to bring it below 6 percent and then try to keep it closer to the 4 percent target. It is a long struggle. Although the Reserve Bank is tightening monetary policy and monetary conditions to curb inflation, economic growth may not be as strong as expected. GDP growth in the first quarter of the current financial year was 13.5 percent against the Reserve Bank's estimate of 16.2 percent growth.

In such a scenario, the growth rate is expected to remain below 7 percent during the current financial year, based on the estimates for the next quarter. For example, the index of industrial production stood at 2.4 percent in July. However, the RBI will have to focus on inflation despite the slower-than-expected growth.

Analysts expect the policy repo rate to increase by 35-50 basis points by the end of this month. Given the continued pressure on prices, the Monetary Policy Committee would be better off raising policy rates by 50 basis points. The Reserve Bank is also trying to curb inflation by aggressively tackling rupee volatility in foreign exchange markets. Since the external situation does not seem to change in the near future, not allowing the rupee to adjust may lead to an anomaly which is better avoided.