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An inflationary fire in the mind

An inflationary fire in the mind
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First Published: Tue, Apr 12 2011. 08 29 PM IST
Updated: Tue, Apr 12 2011. 08 29 PM IST
High inflation expectations are getting embedded into the Indian economy—a danger that is not been given its due in discussions about economic policy.
The Reserve Bank of India (RBI) on Monday released its latest inflation expectations survey of households. The average Indian now expects prices a year down the line to be 13.1% higher than their current level. Inflation expectations have been climbing for quite some time now.
Why is this a problem? Families fearing the ravages of inflation on their purchasing power will push for higher wages and could set off a price spiral. Companies could find it difficult to assess the profitability of new projects when prices are bouncing around.
The new inflation expectations number comes a day after the International Monetary Fund asked whether India is in danger of overheating, even as it cut the country’s growth forecasts for 2011 and 2012. The question posed by RBI deputy governor Subir Gokarn earlier this month no longer seems rhetorical: is a high rate of inflation the new normal?
Ordinarily, this might be interpreted as posing a dilemma for a central bank. Any further hikes in policy rates may “kill” growth while not raising them may lead to higher inflation in the months ahead as inflationary expectations appeared to have been unhinged. The assumption behind this dilemma is the usual trade-off between unemployment and inflation in the short-run. In reality, such a trade-off is illusory at the moment: the possibility that at higher rates of inflation, investment growth may be hit is very real.
Even a cursory look at components of gross domestic product figures from 2003-04 to 2010-11 shows this clearly. Barring 2008-09, when the global financial and economic crisis hit India and 2010-11, investment demand has often outstripped consumption as a source of growth. If care is not taken to ensure the right conditions for fuelling this source of growth—and they are not right at the moment—it will surely hit the overall rate of growth. RBI must avoid this.
The growth-inflation trade-off has been overstated for too long. If anything, evidence from China and India (the latter especially after 2002-03) shows that low inflation and high growth are not mutually exclusive. To say that Indians must learn to live with high inflation if they want to enjoy the fruits of growth is a cruel argument.
Should RBI continue to raise policy rates? Tell us at views@livemint.com
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First Published: Tue, Apr 12 2011. 08 29 PM IST
More Topics: Ourview | RBI | Inflation | Growth | Subir Gokarn |