The Reserve Bank of India (RBI) bats for a rate hike as inflation continues to be the central concern. “Inflation remains elevated beyond the comfort level, despite non-food manufactured inflation having shown some modera­tion in recent mont­hs sug­gesting that monetary acti­ons are having an impact,” the RBI said in its macroeconomic and monetary developments, ahead of its second quarter review of monetary policy on Tuesday.

“Despite the concerns on growth, inflation continues to be high and if RBI does not tighten rates it may be difficult temper it later. The bank prefers to be ahead of the curve rather than behind the curve. Capacity constraints and the bleak investment cycle are the key downside risk to gro­wth but that is related to the global recovery, which continues to be stagnant. But it will be difficult to control inflation without a rate hike,” said Jehangir Aziz, chief ec­onomist at JP Morgan.

Going forward, the gro­wth inflation outlook will do­minate the policy response, and the nature and timing of monetary policy actions wo­uld have to be conditioned by expected effectiveness in attaining the intend­ed goal, the Central bank no­ted in its pre-policy document.

Capacity constraints in some sectors along with increasing pricing power of the firms due to a stronger gro­wth momentum is a source of risk to the inflation pro­cess the RBI cautioned in its macroeconomic policy. Despite some moderation in recent months IIP fell to 5.6 per cent in August from 15.6 per cent in July.

The persistence of food inflation not only has adverse welfare effects as the poor have larger share of food in their consumption basket but could also impact the core inflation after a lag, causing a generalisation of price pressures.

“RBI may hike rates by 25 basis points but it is certainly coming nearing the end of the monetary tightening. The downside risk of the growth is the private capex is not picking up so RBI will st­op rate hikes sooner than la­ter as inflation is following a predictable pattern and RBI will be able to meet its year end target of 6 per cent,” said Abheek Barua, chief ec­onomist at HDFC Bank.

While non-food manufa­cturing inflation, which cou­ld be seen as most responsive to monetary policy, has shown some moderation, elevated food price inflation is a cause for concern. The monetary policy measures introduced since January 2010 could be expected to help in moderating the headline inflation by 2011.

The possibility of rigidity in food inflation, however, cannot be ruled out, unless the supply situation is improved with structural measures to match the growing demand for non-staple food products. Anchoring inflation expectations in such an environment is a difficult challenge for monetary policy.

The headline inflation rose to 8.62 per cent in the September on higher food prices from 8.5 per cent in the previous months after six straight months in double digits through July.