The Hindu Business Line : Swift, lightning action to check inflation needed

The danger is that at the current low interest rates, it will become profitable to stock more goods than for immediate demand , leading to the worse disease of demand pull inflation.

INFLATION continues to haunt policymakers in the Government and the Reserve Bank of India.

It has good reason to - spiralling onion prices derailed the ruling party in Delhi Assembly elections some years back. A coalition, with a shaky majority, cannot be blamed if it does not want to take any chances.

Hence, last Saturday towards market close, the RBI nudged the Cash Reserve Ratio (CRR) upward to 5 per cent from 4.5 per cent and reduced the interest rate on it to 3.5 per cent from 6 per cent.

The move will reduce some of the "excess liquidity" in the system (and incidentally shore up the RBI's bottomline, hit badly in recent times by its forced acceptance of repo funds of tens of thousand of crores everyday as well as declining coupons on and stocks of Government securities).

In fact, the Prime Minister had cleared the way for the central bank's CRR hike, when, at his press conference, he attributed the rise in inflation partly to liquidity overhang.

The RBI has, in fact, been on a mop-up exercise for some time now. Its Market Stabilisation Scheme (MSS) bonds were also designed to withdraw liquidity by sterilising the funds, i.e., making them unavailable to Government.

Obviously, the strategy is to ensure that surplus liquidity does not lead to inflation.

With price indices moving higher every week, in the short-term, the risk is more one of inflationary expectations building up than inflation itself.

The great thing about the increase in CRR - which is the mildest of mild medicines - is not so much that it will remove excess liquidity - - even the MSS bonds though issued already in thousands of crores with a corpus of Rs 80,000 crore have been unable to do that - - but send a strong signal of the Government's and RBI's determination to bring headline inflation under control.

Still, the danger is that at the current all-time low level of interest rates, it will become profitable to stock more goods than for immediate demand, if the market expects inflation to keep rising, leading to the worse disease of demand pull inflation from an accommodative monetary policy.

The next few weeks will, therefore, bear close monitoring of prices, especially those of primary articles and commodities.

If these sound alarm bells, maybe the time would have come for tough action. It might become necessary to constrain liquidity much more severely and effect a sharp rise in interest rates.

Once inflationary expectations are killed - - with punitive steps this will happen much sooner than later - - , monetary conditions can quickly be brought back to normal.

Our economy needs to grow rapidly. We cannot afford to derail growth in the process of derailing inflation.

We must strike hard and immediately so that it does not linger and detract attention from the far more pressing development issues.

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