The Hindu Business Line : Opportunity and challenge

The harried housewife shopping for vegetables may stare in disbelief at the news that the inflation rate has dropped to 8.98 per cent from double digits just a few weeks ago. The RBI will sigh in relief that the Wholesale Price Index has indeed fallen enough for it to feel comfortable initiating a softer monetary policy sooner than later. If falling global commodity prices led by oil, which has slid below $50 a barrel, continue the trend, the RBI and North Block may just b e proved right in their prognosis of an inflation rate not above 6 per cent by March. But global commodity prices are also dropping because of falling demand as developed economies slip into recession. For entirely different reasons, demand in India too is weakening and is likely to precipitate the slide in inflation rates. For policymakers, this is both a challenge and an opportunity.

It is an opportunity for the RBI to ease its benchmark rates that would encourage banks to lower their own lending rates. By now it is fairly well known that three years of high interest rates have added to manufacturing costs and discouraged incremental consumer demand which, in turn, has forced firms to cut back production. The result of that vicious cycle is evident in the fall in industrial production to around 4 per cent in the first half of the current fiscal from 8 per cent in the corresponding period last year. Cheaper money makes it easier for the Government to assume the mantle of the biggest spender to revive private investment that has taken a beating of late. With the expansion of real gross capital formation falling 4 percentage points below last year’s 13 per cent and with the prospect that it may fall further this year as private firms stall their capex plans, the current drop in inflation offers a host of exciting possibilities.

But it also poses challenges for producers and policymakers. The Government must loosen its purse strings wisely and with an eye on results; so too must producers. One of the virtues of the recent illiquidity and high cost of domestic funds has been a focus on prudence and innovative cost cutting by private firms. That trend must continue but now it will fall on the prime mover of investments, the Government, to set the example when money becomes cheap.

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