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S. Balakrishnan

INFLATION is capturing the headlines.

It has risen dramatically from below 5 per cent to over 7.5 per cent in just the space of a few months and reversed the equally dramatic fall in interest rates, which had occurred in the last five years. Are the good times coming to an end?

The Government and RBI are rightly exercised about the jump in inflation. Is monetary policy too loose? Is the fiscal deficit adding fuel to the fire?

No one the world over knows the exact links between money, Government finances and inflation.

They are obviously related but it is hard to put one's finger on when and how much easy money and an "irresponsible" fisc will spark off an uncontrollable increase in the general price level.

After all, going by the canons of many, our burgeoning deficits coupled with the RBI's generous financing of the Government, we should have met Armageddon quite some time back.

There is also the problem of how to measure inflation and its differential impact on various income groups. Especially in a country like India, an increase in the prices of basic necessities affects the large numbers of low-income households, but may hardly make a dent in the considerable numbers of middle and above classes (who are more likely to complain of rising petrol prices).

Complicating the situation is the almost complete divorce in composition between our wholesale price index (WPI) and consumer price index (CPI). While the WPI, the headline inflation number, has been throwing alert messages, the CPI is muted and has gone up only about 3 per cent in the last year.

Which should one believe? In the US, they rely more on the CPI than their WPI counterpart (if one could call it that), the producer price index (PPI). As long as PPI pressures are not transmitted to the CPI, the Chairman of the US Federal Reserve, Mr Alan Greenspan is content. Even in the CPI, far more importance is accorded to the figures net of food and energy price movements, which are considered volatile and contribute "noise" to the data.

Of course, we need to act on inflation. But we also must get our act together on defining and understanding our data and their context better so that we do not come up with policy responses that do more damage than good.

An example is the advocacy of higher interest rates in the current situation when our inflation problems appear to be almost entirely energy import related. Fortunately, the RBI has signalled continuance of its present liquidity stance with the recent reintroduction of the one-day repo.

This should reassure markets that policy and money will not be tightened beyond the strategy of issuing market stabilisation scheme (MSS) bonds as and when necessary, to drain excess liquidity.

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