Almost one year back, I had written in this column that a future with oil at $100-plus a barrel, food shortages, and capital flows that we did not know what to do with would represent a failure of all our policies and our strategies. We are there now, with little evidence that circumstances are going to improve. We should see oil nudging $150 by end-year — I had suggested $200 by 2010, and that is still likely. The current wheat crop and the availability of rice may be a breather against food price inflation, but the balance is fragile, and with just one poor monsoon, there would be serious problems in foodgrain availability. As a consequence, the inflation issue will not go away.
As a country, we have not been very good at thinking long-term or even medium-term. At the same time, we have excelled in managing crisis, whether economic, natural disaster or external aggression. The crisis now is in management of inflation, since it is first a political issue and, of course, it affects the ordinary citizen, who is (surprise!) the voter. So, I am confident that inflation will be managed through fiscal and monetary interventions.
Some fiscal and policy measures have already been taken. The easing of tariffs for edible oils and pulses, coupled with reports of a good mustard crop, and of better than expected sowing of oilseeds. Other measures, such as the dehoarding exercise, the negotiations with the steel producers to bring down prices and the like, are the traditional weapons of the government, rusted, and of little value except in the media.
The attention, therefore, has now shifted to the Reserve Bank of India (RBI) and the measures it will announce as part of its monetary policy statement on Tuesday. It is likely that RBI may look at inflation data in three boxes: food, oil and other commodities. While food products, most importantly wheat and rice, are a function of domestic supply, and given that expectations of government stockpiling are likely to be met, it could be concluded that until the monsoon, there is no likelihood of any sudden spurt in food prices. At the same time, there is likely to be a concern over prices of imported commodities, and oil. These prices would be rising, given the robust growth of the emerging economies and the pressure on the dollar. RBI would probably report that inflation expectations are more serious than originally thought, and that the 7% WPI-level inflation is unlikely to go away for some more months, with decent successive harvests being crucial for tackling food price inflation.
There has also been the argument that the interest rate cuts by the US Federal Reserve have created large arbitrage opportunities waiting to be exploited in the Indian financial markets as soon as volatility goes down a little here and, therefore, interest rates need to be adjusted downwards. In the face of current WPI figures, this argument is unlikely to be pressed further for the moment.
RBI has already intervened by raising the CRR by 50 basis points to 8% to dampen inflation expectations. The CRR hike would help contain the second round pass-through effects of higher import prices, even though it can do little to affect supply-side influences from global commodity markets. The monetary tightening caused by the CRR hike will complement the fiscal measures already taken, in the form of reduction in customs duties.
Therefore, there is a good case for RBI not to increase interest rates further on 29 April — it has not raised interest rates since the repo rate increase of March 2007. At the same time, the policy statements on inflation are likely to be strong, so that subsequent monetary action cannot be ruled out. The focus of the policy could well be on liquidity management, rather than a hike in rates or currency appreciation.
Exchange rate management is likely to be less under pressure in the next few months, as the worsening of the current account deficit has been far slower than the growth in the merchandise trade deficit. There has been a significant growth in “invisible” flows that are accounted for by software and business services, as well as remittances by Indians abroad. The invisible surpluses are around 6.5% of GDP in 2007-08 ($78 billion) against 2.3% of GDP in 2000-01. This is likely to cross 7% of GDP in 2008-09, and will help check the worsening current account deficit due to higher oil prices. The RBI monetary policy review is likely to focus somewhat less on currency flows and appreciation this time.
Finally, RBI is quite likely to comment on the growing subsidies. In an election year, it is not possible for the government to pass on the increased costs of oil and commodities to consumers, and more outlays for food and fertilizer subsidies as well as off-budget oil bonds are likely. There is little possibility that the fiscal deficit of 2.5% of GDP promised in the last budget will be achieved, and it is certain that RBI would comment on the worsening fiscal situation.
S. Narayan is a former finance secretary and economic adviser to the prime minister. We welcome your comments at firstname.lastname@example.org