The Hindu Business Line : An apt response

There is little doubt that inflation control is the key macroeconomic challenge at this juncture and requires a well-measured policy response. In the last few months, along with monetary tightening, a variety of fiscal and trade-related measures have been put in place to tame inflation.

Inflation, however, continues to rule in double digits. Inflationary pressures are expected to persist for the next few months due to the base effect and the intensity of the supply-side shock from crude oil and commodity prices.

Further, the underlying threats to the current inflationary situation no longer appear to be merely ‘supply-side’ driven. The oil price shock is no longer considered temporary, but rather more persistent in nature. Moreover, money supply growth in the economy, at 20.5 per cent, is still above the RBI’s target of around 17 per cent. Thus in the current situation, despite growth concerns, the RBI had little option than to continue with monetary tightening.

There are serious concerns on the slowing growth momentum of the economy.

The IIP data reveals a sharp downturn in the pace of industrial expansion. Earlier, the impact seemed to be limited to the durables segment but now there is some evidence that even investment is being impacted.

Tough choices

In the scenario of slowing growth and a sharp pick-up in inflation, the RBI was faced with a very tough choice in balancing growth and inflation objectives. Experience suggests that even if the shock to inflation is from the supply side, easy monetary conditions serve as breeding ground for further intensifying inflationary pressures. This typically happens when the supply-side shock is intense and is expected to continue.

The drop in crude oil prices from over $145 to $125 per barrel is definitely good news on the inflation front. But, even at the prevailing levels, crude prices are uncomfortably high. There is still a fair deal of uncertainty on global commodity and food prices and, hence, being vigilant on this score is important.

Growth compromise

The continued global financial turmoil also underscores the uncertain outlook on the state of foreign flows on the capital front, making liquidity predictions on the domestic front that much more challenging. Clearly, the RBI does not want to take chances and has, hence, clearly indicated its preference for tight monetary policies in this statement. While this will ease the secondary pressures on inflation, the primary pressure from supply constraints will continue.

The growth concerns notwithstanding, a bitter pill from the RBI was needed to stem the inflationary pressures, going ahead. This would, of course, imply some compromise on the growth front, more so in the next fiscal, as monetary measures impact the real economy with a lag.

The RBI has done its job. Now the government should use the opportunity from the new political configuration to push ahead some pending reforms to raise the growth potential of the economy.

(The author is Managing Director and Region Head, Standard & Poor’s, South and South-East Asia.)

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