The Hindu Business Line : Inflation is destroying the well-earned rupee

Growth carries its own cost, inflation. That inflation has peaked 5 per cent and is climbing is a wake up call for India. Else it will have to pay a dear price of neglect. Particularly worrying is that the price rise is not the result so much of external forces, as crude oil price hikes, as internal scarcities and, paradoxically, too much affluence concentrated in urban pockets, says ASHOAK UPADHYAY.

As 2006 draws to a close, the news on the economy could not have been better; month-to-month the GDP growth rates offer eloquent confirmation of the cautious forecasts by both the Reserve Bank of India (RBI) and North Block for the fiscal. It would not be surprising if someone floated a 9 per cent growth balloon for the year.

The Government is in celebration mode as just about every indicator suggests that the economy is galloping towards double-digit growth. That scenario must sound sweet music to the policy-maker's ear together with the news that the Chinese economy is headed for a cooling down after years of rapid-fire growth.

India is shining

If statistics are anything to go by, India is shining because manufacturing is humming. Every month, the Index of Industrial Production betters its own performance of the corresponding previous month. Just last December, the Prime Minister exhorted industrialists to aim for 10 per cent growth in manufacturing.

Now the bar has been raised to 14 per cent and no one is blinking. Partly because industry had crested this peak in 1998, but mainly because of the brimming self-confidence, a sentiment that is shared by other sectors such as services and banking.

Credit growth has been fairly brisk despite four hikes in repo and interest rates. The market is able to bear the hikes because the urban middle-class has higher disposable incomes than ever before. Retail loans surged nearly 50 per cent compared to overall credit growth of 30 per cent in 2005-06.

World economic growth seems to confirm India's own prosperity; since 2004, it has grown 5 per cent on an average, the highest since the 1970s. The difference is that the US no longer leads the pack as much as Europe and Asia.

Important as the US' fortunes are to the rest of the world, the numbers put China, India well ahead. China's growth is export-driven and the sheer force of its exports is evident in Europe's record trade deficit that surged 21 per cent this year.

The price of neglect

But growth carries its own cost and that is inflation. Much as the Indian middle-class, seduced by its own prosperity, may belittle or ignore the figure, the fact that inflation in this country has peaked 5 per cent and climbing is a tell-tale sign that sooner than later India will have to pay the price of this neglect.

Particularly worrying is that the price rise is not the result so much of external forces, such as the crude oil price hikes, as internal scarcities and, paradoxically, too much affluence concentrated in urban pockets.

World oil prices are falling; at $55 a barrel they are $20 lower than the level at which the government-hiked domestic petrol prices. Yet, the Petroleum Minister has made it clear that a downward revision is some distance away. He has the oil companies to think of.

More than fuel prices, it is the combination of domestic price increase that is contributing to the inflation rate's steady climb. For a country that had declared itself self-sufficient in food decades ago, nothing is more scandalous than the scarcity of foodgrains and essential commodities that sends their prices soaring. By June 2006, the Consumer Price Index for Industrial Workers had spurted to 7.7 per cent. Government intervention in the form of restrictions on exports or encouraging imports did little to contain the upward movement of price; the index fell a little, then rose to 6.8 per cent in September. But the CPI for rural labour crossed 7 per cent that month creating a record, after six years of low prices. It is not getting any better because the area under foodgrains this kharif is down almost two per cent

As if that were not bad enough, prices of manufactures too have begun to climb. The Wholesale Price Index (WPI) for manufactures rose from 1.9 per cent in April to 4.4 per cent in October, encouraged by an unabated increase in consumer spending. As result of overall price increases, the headline inflation is well over five per cent in a year that will best previous records for high GDP growth.

Headline inflation

The Government's responses to the price surge have ranged from a benign indifference to a misplaced faith in monetary policy Barely four years ago, headline inflation was under three per cent. Since then it has been inching upwards even as the GDP growth has moved onto the fast lane.

generous central bank presided over the fastest growth in credit to the services sector, especially housing and consumer durables. It was only in the last 12 months that the Reserve Bank of India voiced concern over the inflationary pressures that "excessive borrower optimism", to use Dr Y. V. Reddy's phrase, were generating. The response, four hikes in repo rates and the subsequent interest rate spikes by banks, has been so marginal as to have little impact on that borrower optimism.

Interest rate changes work with a lag and will, perhaps, begin to dampen enthusiasm some time next year but, by then, inflationary pressures would have worked their way into the interstices of the economy.

The real danger is that the monetary reflex may not work at all given the nature of the current inflation. Fuelled by scarcities, the general price rise will not be deterred by interest rate hikes so much as by a concerted attempt at filling those shortages in foodgrains and essential commodities.

An equal danger lies in neglecting the need to revamp current inflation measurement indices. None of the indices in use reflects the surge in asset prices during the current boom.

Real-estate prices are shooting skywards fuelled by speculation and a wide acceptance of unaccounted money in transactions. Even as cities decay with collapsing civic services, frightening pollution, and grimy neighbourhoods, real-estate values keep escalating. That rise in asset prices propelled by unabated demand is also adding to inflationary pressures.

Tighter monetary policy

Since neither the CPI variants nor the WPI considers asset prices because there is no official data on them, there is no way of plumbing the depths of the real inflation at work that is destroying the value of the well-earned rupee.

A tighter monetary policy is becoming overdue because the "irrational exuberance" in retail credit, particularly in housing, is adding to the general price rise more than is good for the economy at large. But for this approach to work, the RBI has to arm itself with information on the surge in asset prices.

A housing index with appropriate weights will help the central bank use its interest rate policy to better effect in curbing prices. Till such time, however, housing will remain a distant dream for the vast majority of the poor, as inflation will corrode earnings.