The government said on Monday inflation surged to 8.56 per cent in January, the highest in over 13 months, ahead of the Union Budget for 2010-11 that would spell out the stance on stimulus packages.
Inflation, which has already breached the Reserve Bank of India's estimate of 8.53 per cent, has also fuelled concerns that the apex bank could further tighten the monetary measures initiated earlier this month in its third quarter monetary policy review.
Projecting that inflation would touch 8.56 per cent by current fiscal-end, the RBI had sucked out about Rs 36,000 crore (Rs 360 billion) from the banking system to check the rising prices. Over one-year high inflation was led by costlier sugar and potato prices.
Sugar rates rose by 58.96 per cent while potatoes turned costlier 53.39 per cent. Economists predict inflation to reach 10 per cent by fiscal-end, making the roll back of stimulus measures a tricky issue for Finance Minister Pranab Mukherjee.
"There is a tough balancing act ...in the Budget. If he withdraws stimulus then it would put pressure on inflation.
However, withdrawing stimulus is necessary to reduce fiscal deficit," Crisil Principal Economist D K Joshi said. In the wake of the global slowdown in 2008, the government had announced many sops, including cut in excise duty, to prop up the then slowing economy.
Now that the industrial growth is also at 16-month high of 16.8 (December), experts feel the upcoming Budget may see stimulus being withdrawn. Investors' fear about the government rolling back stimulus had the benchmark Sensex on Bombay Stock Exchange closing down by over 100 points.
To help the industry tide over the impact of the global financial crisis, the government came up with three stimulus packages sacrificing Rs 1.86 lakh crore in revenue.
The stimulus packages, which included tax cuts and raising public expenditure, are estimated to push the fiscal deficit to 6.8 per cent of the gross domestic product from 6.2 per cent a year ago. Riding on the back of stimulus the Indian economy grew at a stunning rate of 7.9 per cent in the second quarter of 2009-10.
This prompted the RBI also to revise its growth projection upwards to 7.5 per cent for the fiscal.
After industrial production grew by 16.8 per cent, Mukherjee had also said that it would have a positive bearing on the GDP.
However, economists say with inflation at a 13-month high, the government is faced with the classic dilemma of choosing between supporting growth and curbing inflation. On monthly basis, prices of masur increased by 9 per cent, arhar by 6 per cent and wheat by 4 per cent.
Fuel index rose by 1.8 per cent due to higher prices of naphtha, which rose 21 per cent. Furnace oil rose 6 per cent while bitumen, non-coking coal and light diesel oil rose 3 per cent each.
Many economists feel finance minister Pranab Mukherjee would partially roll back stimulus measures in the Budget, which will be unveiled on February 26.
"Withdrawal of stimulus is a gradual process and this budget I expect CENVAT would be inched up to give a signal that the stimulus cannot remain forever," said Suresh Tendulkar, former chairman of prime minister's economic advisory council.
