New Delhi: A sudden spurt in inflation, which has clearly taken policymakers by surprise, threatens to upset finance minister P. Chidambaram and his team’s plans and big ideas for Budget 2007-08, to be unveiled in a week.
Can he win the battle against high inflation and protect growth? Or will the economy end the current fiscal with 7% plus inflation, which would derail the unprecedented growth momentum? Overwhelmingly, experts vote for policies to lower inflation even if it means sacrificing growth a tad.
The Budget may include many fiscal steps to ease the burden on the common man. Excise and customs duties on several goods are slated to come down, and some income tax relief may be announced.
This is because the Indian populace, particularly the middle class, is very reactive to inflationary pressures, especially with respect to everyday items of food consumption—onions are ruling at Rs25-30 a kg, double the usual level of Rs12-14 a kg. The Prime Minister has asked his office to closely monitor inflation. Says a senior finance ministry official who didn’t want to be named: “It’s like the El Nino effect. Expectations are higher. So is the denominator. The bankability of 9% growth has gone up. If we can do something, we will.”
Traditionally, the Reserve Bank of India (RBI) has a one-point agenda while it manages the currency and the amount of money flowing in and out of the economy and within it: to keep inflation in check. This year, inflation measured by the wholesale prices of 435 commodities is at 6.73% compared with less than 4% a year ago. Consumer price indices, which are attuned to food items, are above 7.5% on average.
The current price rise is driven by double-digit inflation in food prices, as also high prices in some manufactured articles where production is short of demand. With the economy slated to grow at 9% for the year, RBI has been tightening money to slow credit demand rising year-on-year at 30%. Since bank lending rates have crossed 11%, compared with 9% a year ago, the worry is that this may hurt some sectors of the economy.
Economists say that there is no need for a trade-off between high growth and low prices, even though, faced with a choice, they’d unhesitatingly choose the latter. Says Shankar Acharya, former chief economic advisor, finance ministry: “There is a bit of a trade-off involved. Both short-term and long-term measures are necessary, and I wouldn’t mind the speed of growth reducing a bit in the short-term. Also, if we look at the average numbers for the past 6-7 years, we have had less than 5% inflation. So I wouldn’t really advise panic raising of interest rates in the short run, nor do I think that steps like petrol price cuts serve any purpose.”
M. G. Rao, director, National Institute of Public Finance and Policy feels that the lack of futures trading in commodities, failure to align with global prices and the inability of the agriculture ministry to foresee the supply shortfall are the factors responsible for the primary products inflation.
Part of the reason for the ministry’s complacency, says Shashank Bhide, research head, National Council for Applied Economic Research, is “the demand for foodgrains had been going down significantly in the past few years, so the supply situation may have been misjudged.”
But, counters Acharya, with the post-reform trend growth in agriculture flat at 2% and demand for commodities growing in tandem with rising growth and incomes, “supply constraints were bound to surface. I’m puzzled that we managed to mismanage the wheat stocks. At our time, we monitored it on a weekly basis.”
Do we then need more fiscal measures like import and excise duty cuts to allow a somewhat freer flow of goods than simply monetary tightening? Bhide says that sooner or later, inflation in manufactured articles would present a bigger worry. “Chances are that there’d be a cooling off in farm prices, but steel and some manufacturing prices face a bigger challenge, next year. Some excise cuts would definitely help in their case.”
RBI’s continuous move to tighten money too has helped. Acharya sees credit growth tapering off, thereby precluding another round of rate hikes.
But A. Prasanna, vice-president, ICICI Securities, thinks that “since most of the monetary tightening has happened in the past three months—the RBI has been behind the curve before that—its real impact on both credit and gross domestic product growth would be felt only after April.”
Bimal Jalan, former RBI governor, differs too. “Nobody’s telling you what the inflation rate is expected to be. I don’t see the need to be defensive about monetary measures. If real estate prices are growing at 200%, something has to give somewhere. There is an obvious conflict of objectives,” he says.
Both interest rates and even perhaps inflation have some way to go before they can peak. So, look at controlling deficits and smoothening supply will be top priority with government. The Budget is certain to reflect that on 28 February.