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Government looks for 7% solution

Government looks for 7% solution
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First Published: Sat, Apr 05 2008. 12 17 AM IST

Updated: Sat, Apr 05 2008. 12 17 AM IST
New Delhi: Inflation, as measured by the rise in wholesale prices, touched a three-year high of 7% for the week ended 22 March, and with just a month to go before elections in the important state of Karnataka and in a year which will see elections to several other key states, it threatens to become for the ruling United Progressive Alliance (UPA) government, what the mistimed India Shining campaign was to the National Democratic Alliance that ruled the country between 1999 and 2004—the x-factor that can upset electoral calculations.
The current spurt in inflation rate has come about despite a high base (inflation at the same time last year was 6.54%).
From the Reserve Bank of India’s (RBI) point of view, the more worrying thing is the impact the acceleration for the seventh consecutive week will have on inflationary expectations, and thereby on consumption, savings and investment habits in the country. Lenders, investors, borrowers and customers will all change their behaviour if they expect inflation to continue to rise— customers, for instance, will spend less and defer purchases —and this could have significant economic implications.
Some experts expect inflation to rise further and touch 8%.
The stock markets reacted badly on Friday, with the Sensex, the benchmark index of the Bombay Stock Exchange, losing 489.43 points to close at 15,343.12. On Friday, a government report in the US said that American employers cut 80,000 jobs in March, the biggest decline in employment in five years. At 8.30pm India time, the Dow Jones Industrial Average was trading 34.77 points down at 12,591.26, and India’s stock markets will likely fall again on Monday when they open after the weekend. While the US data and the stock market are not related to inflation, they will add to the general aura of gloom that is beginning to surround India’s macro-economic indicators.
Friday’s data on inflation may actually hide a even higher increase in retail or consumer prices. The data is also provisional and will be revised in eight weeks; thus far this year, final data on inflation based on wholesale prices has been almost 50 basis points higher than provisional data.
The government carried on where it had left off on Thursday, and withdrew export incentives on basmati rice to improve supplies and check prices. It has already reduced import duties on several products and is also asking manufacturers of key raw materials, such as steel, to reduce prices.
RBI, analysts say, will seek to manage demand in the economy by more measures to make money expensive, which will also have a bearing on the overall growth prospects.
On Friday, even as rumours swirled about a possible increase in the cash reserve ratio (CRR), which defines the balance banks need to keep with the central bank, RBI announced the sale of Rs5,000 crore of bonds through the market stabilisation scheme next week. This is in addition to a scheduled auction for Rs10,000 crore worth of bonds. All together, experts say, there is around Rs35,000 crore of excess liquidity in the system.
“We will not hesitate to take the strongest possible measures, including some of the legal provisions that we have, against hoarding,” commerce minister Kamal Nath said, four days after an emergency meeting of the Cabinet Committee on Prices announced several anti-inflationary measures.
However, experts predicted another round of increase in prices.
“The next bout of sharp rise could well happen in cereals, where inflation at home is only about 6% while global inflation is far higher. Even increased imports of essential commodities will not work as tight supply situation in cereals has kept prices hard. Then there is still some gap between Indian and global metal prices as well,” Dharmakirti Joshi, principal economist with credit rating agency Crisil, said.
Robert Prior Wandesforde, India economist at HSBC, said he expected the inflation rate based on the wholesale price index to soon soar to 8%.
“Price rise is a concern. We hope the measures taken by the government will have an impact,” B.K. Hariprasad, a Rajya Sabha member of the Congress party from Karnataka, said.
Arun Jaitley, a Rajya Sabha member of the principal Opposition, Bharatiya Janata Party (BJP), and in charge of the party’s campaign for Karnataka polls, said: “The UPA came to power on the slogan of aam aadmi (common man) and unchecked inflation has now become an unlegislated tax on the same common man.”
Analysts say even expectations could play a big role, encouraging hoarding and random markup of prices by producers. Expectations of higher inflation and tighter monetary policy recently prompted IDBI Bank to drop its plan to cut the prime lending rate (or the rate at which its best customers could borrow from it) from April.
On Monday, RBI governor Y.V. Reddy had warned about the possible impact of this. “We are very, very concerned about the impact of the recent spurt in inflationary expectations,” he said. “We have to make sure that aggregate demand continues to be consistent with supply-side initiatives by the government.”
Finance minister P. Chidambaram has maintained that the current spike is propelled by soaring international prices for food, energy and industrial metals.
Pronab Sen, chief statistician of India, agreed. “India is still quite insulated from the global price rise, which has been 85% in wheat and 100% in rice.” In just around a month, inflation has climbed by almost 40%, from just more than 5% on 23 February.
Meanwhile, the political pressure on the government is growing.
BJP, as well as the government’s key ally, the Left Front, both said they would go ahead with targeted anti-inflation campaigns from next week.
BJP had announced a week-long countrywide campaign from 7 April; the Communist Party of India (Marxist), or CPI(M), had given the Congress-led UPA a deadline of 15 April to bring prices under control; and the Communist Party of India had announced an agitation on 17-18 April.
“There is not much the government can hope to do in a hurry,” economist Parth J. Shah, president of the Centre for Civil Society, a New Delhi-based think tank, said.
“But there is a silver lining for the country as well as the Congress party, if it can seize the opportunity,” Shah said. “Just as the balance of payments crisis in 1991 turned out to be boon for the industry, supply-side concerns can turn 2008 into a turning point for long-pending agricultural reforms.”
Brinda Karat, a Rajya Sabha member of CPI(M), however, said the government had failed because it did not listen to the suggestions given by it and other constituents of the Left Front. “This is the result of giving up all control to the market forces.”
Emerging countries have been battling inflation from late 2007 as growing demand for commodities has fuelled speculation in a tight market. “Even the US has seen inflation double, while in China it reached a 12-year high of 8.7% in February,” said Ashok Gulati, director (Asia) at the International Food Policy Research Institute.
Following the run-up in inflation, Goldman Sachs now expects RBI to increase interest rates in April, economist Tushar Poddar said in a research note. Some analysts, such as Rajeev Malik, executive director at JPMorgan Chase, expect a 50 basis points hike in CRR, anytime before or during the monetary policy review slated for 29 April.
Joshi said RBI will stay its hand for now because the current spike in inflation is on account of supply-demand imbalances. “An interest rate hike will have no effect,” he added.
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First Published: Sat, Apr 05 2008. 12 17 AM IST
More Topics: Inflation | UPA | RBI | Basmati rice | Sensex |