The Hindu Business Line : Inflation debate

If inflation were primarily a result of global energy and other commodity price spikes, the economy would have probably needed a different set of policies meant to neutralise the impact.

For over a year, policymakers have stressed so much on the threat of inflation to the economy and the need to curb its effects that its spectre has begun to haunt business confidence. The RBI’s repeated increase of the repo rates and cash reserve ratio (CRR) is dictated by the need to rein in excessive liquidity that feeds inflation. The increases, which have taken both to 9 per cent, a full three percentage points above the last year’s level, have yet to arres t the climb of headline inflation, now over 12 per cent. The RBI, however, appears committed to “price stability” and continues to justify its dear money policy because “aggregate demand pressures” appear to be strongly in evidence. Dr Arvind Virmani, the chief economic advisor to the Finance Ministry, differs. While dismissing fears of overheating, he considers inflation principally a result of global price spurts; the RBI blames global prices only “partly”.

If only Dr Virmani’s optimism about growth and inflation had rubbed off on policy over the last eighteen months or more! If indeed inflation were primarily a result of global energy and other commodity price spikes, the economy would have probably needed a different set of policies meant to neutralise the impact. Thus, the rupee would have been allowed to appreciate as in late 2006-07 so that energy and food imports got cheaper. Interest rates would have been reduced, or at the very least held steady to allow the manufacturing sector to maintain its five-year average growth of 18 per cent, a prospect that seems unlikely today. At the same time, the RBI and the Prime Minister’s Economic Advisory Council could pray that the present slide in oil prices continues helping the energy-fuelled inflationary conflagration simmer down to around 7 per cent by March. Since the policy response would have been dictated by the premise that the economy was not overheated — as Dr Virmani avers — one could have reasonably expected banks to maintain credit growth at levels that satisfied the hunger for housing, consumer goods and autos, those drivers of the last five years’ sustained and high growth.

The reality, however, is different because it mirrors a monetary policy driven by the assumption that excessive liquidity is a function of high consumer demand. Dr Virmani is probably right that over the Eleventh Plan, the economy can maintain 9 per cent growth. To start that process, he might want to suggest a different set of policies for the Finance Ministry.