No let-up on inflation control

The recent Report of the Prime Minister's Economic Advisory Council (PMEAC) is a watershed in that it is forthright in asserting that while India was able to negotiate the global economic crisis quite well, we have been unable to find our way back to the path of rapid asset creation and growth.

The policy drift has led to an unintended slowing down of initiatives to restore investment and economic confidence. The Report is emphatic that: “It is certain that the RBI will have to continue to maintain a tight monetary policy for quite some time, given the combination of domestic inflationary situation, the international backdrop and the fairly strong growth that the domestic economy is experiencing”.

The Report recognises that the international situation is not entirely supportive of economic growth. The crisis in Greece, Portugal and Ireland, spreading to Spain and Italy, could have severe repercussions on the global economy. The fiscal deficit in the US of over 10 per cent of GDP and the unprecedented monetary easing have exhausted the capacity to stimulate the economy any further. The large political differences in the industrial countries on how to proceed with fiscal consolidation cast a cloud over any prospects of global recovery.

After the announcement of the RBI's monetary policy on July 26, the Finance Minister, in an unusually categorical statement, warned market participants that there would be a need for further interest rate hikes.

The downgrading of the US rating by Standard and Poor's, from AAA to AA+, resulted in a massacre in global financial markets on Friday August 5, which also spread to emerging economy markets. It is significant that the earlier downgrading of the US by the Chinese rating agency did not impact financial markets.

Avoid knee-jerk reaction

4.Even without any pronouncements by rating agencies, it was common knowledge that the US had a very serious problem but it took S&P to deliver its verdict to trigger a global sell-off. The recent roiling of global financial markets should not result in a knee-jerk reaction in India to abandon the sagacious advice in the PMEAC's Report.

Unfortunately, advocates in influential policy circles in India are already calling for a reversion to monetary-fiscal easing, as was undertaken in 2008.

It would be a serious error of policy if India were to forget its present over-riding priority of expeditiously crushing inflation as monetary-fiscal easing at this stage would only stoke the inflationary fire, leading to serious social tensions. Thus, there is merit in not aping the policies in the major industrial countries.

Investment guru Marc Faber has asserted that the present global economic crisis could be much worse than in 2008. But before such an eventuality, authorities in the industrial countries would take recourse to printing money and this could result in a War.

Nouriel Roubini foresees that Quantitative Easing (QE) 3 could be followed by QE 4 and QE 5. This would, inevitably, generate strong inflationary pressures globally which would inevitably spread to emerging markets.

There has been almost instantaneous clamour by Indian industry to soften monetary-fiscal policies. Moreover, some influential policymakers have already voiced empathy with this viewpoint. It is essential that in India basic policies are not excessively swayed by recent developments in the global economy. We have India-specific problems and these must be addressed on a priority basis. The sinking of global markets should not result in a volte face on the present avowed policy of inflation control. The clear policy of crushing inflation should not be reversed because of global developments.

Key difference

As Dr C. Rangarajan, the economic policy helmsman, has cogently argued, there is an important difference between the level of inflation and the rate of inflation. For instance, if the inflation index rises from 100 to 110 we consider the inflation rate to be 10 per cent. But if the level rises further to 120 we take solace in the fact that the rate of inflation is 9 per cent in the subsequent period.

To the Common Person, the fact is that he groans against an even higher level of prices. Policymakers never talk of a roll-back of the level of prices as this is erroneously considered as a contagion to be totally avoided.

We have waited far too long to tackle inflation, which is Public Enemy No.1. Given the vast tracts of poverty, sacrificing inflation control at the altar of higher rates of real growth would be disastrous from a political economy point of view and moreover, would be morally repugnant.

If at all, the monetary-fiscal tightening should be accelerated and not weakened. The crucial issue is whether the Indian authorities would be excessively swayed by global developments to ease monetary-fiscal policies or whether they would be steadfast in their commitment to control inflation in India.

(The author is an economist. >blfeedback@thehindu.co.in)