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Business News/ Home Page / Would inflation mar India’s growth story?
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Would inflation mar India’s growth story?

Would inflation mar India’s growth story?

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New Delhi: More than ever before, the country’s economic growth strategy hinges on five key interlinked macroeconomic assumptions: inflation, interest rates, the monsoon, crude oil prices and developed economies not relapsing into recession.

This is because economic circumstances have swung between extremes after the world economy plunged into a crisis of the magnitude last witnessed in the Great Depression of the 1930s. In India’s case, the drought of 2009 queered the pitch further, even as it has had to face up to the firming of international commodity prices, particularly crude oil.

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The commitment of Budget 2010 to return to fiscal prudence depends crucially on the country’s ability to sustain and later accelerate economic growth. To help readers understand these exceptional circumstances and challenges, Mint begins a five-part series today.

Inflation

In a trade-off between inflation and growth, finance minister Pranab Mukherjee opted for the latter. His assessment is that the overall inflation will average less than 5%—though in the short term it would cross into double digits—and, hence, he decided to increase indirect levies on items such as petroleum products as he went about the task of restoring fiscal balance.

The bigger concern is that inflation, after being concentrated in food products for the last 18 months, is spilling over into manufactured products. February data revealed that inflation of manufactured items accelerated to 7.4% from 1.6% in October.

The Reserve Bank of India (RBI) had inflation clearly in its sights when it unexpectedly raised the repurchase and reverse repurchase rates by 25 basis points each on 19 March.

Graphic: Paras Jain/Mint

This is not surprising given that food items—wheat, rice, coarse cereals and so on—are wage goods and their persistent rise stokes inflationary expectations. In fact, the Reserve Bank of India (RBI) had in its January policy review, warned that inflation from high food prices could be transmitted over time to non-food items.

Expectations are that the better-than-expected performance of the rabi, or winter crop—which reaches the market in the next month—would have a cooling effect on food inflation. Matters could, however, turn on their head if the country’s annual tryst with the monsoon—the forecast for which is expected in mid-April—turns out to be another disappointment, especially since the rural sector is already under strain after last year’s drought.

However, with food stocks well in excess of the buffer stock norms, the authorities have a sufficient cushion for another year. This, of course, assumes a judicious use of the existing food stocks. So far, the government has shown no inclination to use the stocks to douse food inflation. This reluctance is being attributed largely to the fact that any major intervention ahead of the harvest would dampen market prices and affect the payout to farmers—a key political constituency.

In the final analysis it is apparent that inflation is the key macro wager that could make the finance minister’s growth strategy vulnerable. Will economics trump politics?

Note: This discussion took place before RBI raised policy rates on Friday night.

Tomorrow: Interest rate presssures could nix recovery.

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Published: 22 Mar 2010, 01:15 AM IST
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