The Hindu Business Line : Inflation: Cause for concern, not panic

While controlling inflation is no doubt the overriding priority at this juncture, there is a need to ensure that the growth momentum of the economy does not suffer due to severe monetary tightening and other panic measures.

S. D. Naik

While the rate of inflation measured in terms of the wholesale price index (WPI) crossing the double digit level, to 11.63 per cent for the week ended June 21, is no doubt a cause for concern, clearly there is no cause for panic. However, the response of the Government appears to be one of panic. Evidently, the rapid rise in inflation since January seems to have unnerved the policymakers, more so because of the fast approaching elections.

PANIC REACTIONS

First, the Government banned exports of rice, wheat, pulses and other food articles and brought down the import duty on edible oils and other food items to zero. It also allowed import of steel, iron ore and cement at zero duty. Moreover, to discourage exports of these items, it imposed export duty of 5-15 per cent on these items besides withdrawing the duty drawbacks on exports of metals and cement.

When these measures failed to rein in inflationary pressures, the Reserve Bank of India (RBI) on June 24 raised both the repo rate and the CRR by 0.50 percentage points each. While the repo rate was hiked with immediate effect to 8.50 per cent, the CRR was hiked to 8.50 per cent from July 5 and is to be raised again to 8.75 per cent from July 19.

These steep hikes in the repo rate and the CRR have come in just two weeks of the hike in repo rate on June 11 by 0.25 percentage points to 8 per cent. The CRR was also hiked earlier in April by 0.25 percentage points. What is more, the RBI has further warned that it would act again if necessary to prevent inflation becoming entrenched in the economy. The RBI’s decision to raise CRR as well as the repo rate once again, and that too so steeply, has come as a surprise to many observers and analysts.

There is a feeling that having run out of options to influence the supply side, the Government must have prevailed upon the RBI to assume such an aggressive posture to influence the demand side pressures.

A GLOBAL PHENOMENON

The panic reactions are clearly misplaced at a time when everyone agrees that the current inflation is not confined to India alone. It is a global phenomenon and practically every country, whether advanced or developing, has been affected by it.

The relentless rise in the international prices of crude oil and petroleum products as also of other essential commodities, including foodgrains, processed foods, metals and chemicals, because of worldwide shortages, has contributed to the present situation.

Hence a very large proportion of the current inflation in India is imported inflation. This is also the case with other Asian economies which have been hit by the rising inflationary pressures because of the relentless rise in the prices of crude oil and other commodities.

Currently, the annual inflation rates in China, Thailand, Vietnam, Hong Kong, India, Indonesia, Japan, Pakistan, the Philippines, Sri Lanka and Thailand are much above the benchmark interest rates. The inflation rate in Pakistan has registered a 360-month high of 19.3 per cent, Vietnam has recorded a 192-month high at 25.2 per cent. In China it has moved up to a 140-month high of 7.7 per cent.

A report in the Financial Times points out that the spectre of inflation has returned to haunt the global economy as companies ranging from Dow Chemicals of the US to South Korea’s Posco hiked prices sharply to combat soaring costs of energy and raw materials.

The sustained rise in the prices of oil and commodities has hammered industries such as airlines and carmakers, and deepened fears of a global inflationary spiral — which has already provoked riots in some Asian countries— as producers have been compelled to pass on higher costs to manufacturers and consumers.

NEED FOR PATIENCE

While controlling inflation is no doubt the overriding priority at this juncture, the country will have to live with high inflation for a few more months. Meanwhile, there is a need to ensure that the growth momentum of the economy does not suffer due to severe monetary tightening and other panic measures. Maintaining the growth momentum and employment generation are important to minimise the hardships to people.

Fortunately, there has been a record production of wheat and paddy this year and the country has adequate stocks of foodgrains. Moreover, the crop forecast for the coming year also appears good with monsoon forecast being normal. Better supply management of foodgrains and other essential commodities holds the key in controlling inflation. Unfortunately, the country’s public distribution network is in a shambles and needs strengthening.

According to the Centre for Monitoring Indian Economy (CMIE), inflation is expected to come down to around 5.5 per cent during the financial year 2008-09 and kharif crop is expected to play a major role in this regard. According to Mr Arvind Virmani, Chief Economic Advisor, inflation is expected to come down to 5-6 per cent by this time next year.

While these projections appear too optimistic, there is reason to believe that inflation should come down to 7.5-8 per cent by the year end.

However, most analysts rightly believe that inflation could peak to around 13 per cent over the next two months before it begins to moderate. With crude hovering around $145 a barrel, taming inflation is going to be a difficult task.

WHAT NEEDS TO BE DONE

Since monetary measures become effective with a lag of eight months to one year, the RBI would do well to take a long pause before going for any further rate hikes even if inflation inches up a bit in the short run.

For the measures already introduced by it so far are expected to bring down the growth momentum of the economy. It is now generally agreed that GDP growth during 2008-09 may moderate to 7.5-7.8 per cent.

To reduce the excess liquidity in the economy, the RBI, rather than go for rate hikes, would do well to allow the rupee to appreciate by releasing more dollars in the economy and, thereby, mop up excess liquidity. Such a measure will also bring down the import costs of crude oil and other commodities and thus help in moderating inflationary pressures.

Simultaneously, the Government should curb speculative activities by merchants, traders and middlemen, not by monetary measures but through better supply chain management and an improved public distribution system. For achieving success in this area, there is a need to substantially augment buffer stocks of foodgrains and other essential commodities.