RBI has been increasing interest rates since the last two years to battle inflation, and now high inflation in India has become a favorite discussion point for financial market participants. Many analysts believe that the RBI may have to increase rates further in next few quarters to fight inflationary pressures.
However, we believe that RBI has already started winning the battle against inflation. Although the real policy interest rates in India are still marginally negative, since the market interest rates have become positive in real terms, inflation in India is showing signs of changing direction.
The table below shows the difference between one-year inflation and four-year inflation, as measured by CPI. A positive figure (the green zone) signifies that recent inflation is trending lower compared to longer term trends and vice-a-versa (the red zone).
The above table shows that inflationary pressures started building up in India in full earnest in Q42005 and this continued till Oct 2010. However, recent readings of inflation are in green zone. In fact, the month of May 2011 recorded the first seven month period since 2001 of slowing inflation as compared to longer term trends.
We believe that, this trend reversal, coupled with subdued international commodity prices, will significantly reduce pressure on RBI to continue to raise rates.