Inflation above 6%, pressure on interest rates

Experts say it isn’t much cause for concern because the surge is a temporary phenomenon which will ‘‘stabilise’’ at around 5 to 5.5% by mid-August—in line with last year’s average of 5.32%. But there is reason to worry.

Add to this 6 plus inflation, the government’s admission in the Economic Survey that there could be pressures pushing interest rates upwards and the forecast of a ‘‘weak monsoon outlook’’ at least until the middle of July.

The spurt in inflation also means that bank savings are now getting negative returns as real interest rates (difference between interest rate and inflation rate) are in the negative territory.

The wholesale price index (WPI) inflation rose by 0.22% to 6.09% despite a 3% fall in vegetable and fruits prices. Economists dismissed the view that it was the 2 per cent cess and increase in tax from services which would put an upward pressure on inflation. But on interest rates, there is a virtual consensus: rates were likely to harden in the medium run and rates on instruments above 5 years could go up by at least 0.5 per cent.

Said economist Surjit Bhalla: ‘‘The Budget’s tax proposals are not inflationary. The cess and the new service taxes would not put any pressure on inflation front. Though the government would spend a lot more this year, the bulk of the fund allocation would be in rural areas where vast resources are still untapped. I do not see any inflationary trend in this budget.’’

Saumitra Choudhury of ICRA said that when services are used by the producers as an input for production, they would get a set-off on the service tax. ‘‘To that effect, the impact of the service tax on the prices of goods and products would be minimal,’’ Choudhury said. But he was quick to add that interest rates in the long-term would harden and going by rough estimates, at least 0.25 per cent to 0.5 per cent in a time frame of five years.