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Paradoxes in external and internal sectors

High inflation rate is attributed to supply constraints in primary commodities

PARADOXICAL TRENDS have been discernible for some time now in the external and internal sectors of the economy. Against the heady foreign exchange inflows since April 2006 and the resultant significant appreciation of the rupee against the U.S. dollar and to a lesser extent against some other major currencies, inflationary pressures within the country have not eased noticeably.

This is in spite of the efforts of the Government and the Reserve Bank of India to contain the inflation rate with cuts in import duties and hikes in the repo rate and cash reserve ratio. The inflation rate has remained above 6 per cent mainly due to supply constraints in primary products. These have led to higher prices of essential commodities even though crude and petroleum products imports are cheaper in rupee terms.

Ineffective measures

The realisation that fiscal and monetary measures alone will not help check inflationary pressures in the changed situation is perhaps responsible for RBI Governor Y.V. Reddy not further hiking the repo rate and the CRR. Instead he has allowed the rupee to harden mainly against the dollar without any intervention.

The rupee has already gained by 8 per cent against the greenback in recent months and it was believed that cheaper imports would have a sobering effect on domestic prices and ease supply constraints. However, the expectations in this regard have not materialised as world prices for several products are above internal parity. Even so, the rupee cannot be allowed to appreciate any further and it is already being represented to the Government that the export effort is getting discouraged in many areas. This perhaps explains the modest softening of the rupee presumably due to RBI intervention.

Critical shortages

Serious efforts have to be made to improve supplies of primary products in short supply and provide incentives for sustaining the growth in industrial output and the boom in the services sectors. Emphasis will have to be on boosting the output of food and cash crops, the former particularly.

The demand for foodgrains and other items has risen sharply while procurement operations are not successful in spite of a hike in procurement prices and grant of a bonus. Even though the rabi wheat crop has increased by over 4 million tonnes, farmers are not keen to tender their surpluses to government agencies, except in Punjab, as open market prices are attractive.

Shortage in wheat supplies is inexplicable as procurement purchases in earlier years had been much more than offtake. As even a bumper crop is not found adequate, a new strategy is needed to raise output of this cereal beyond 80 million tonnes.

The Agriculture Ministry has therefore decided to import 3-5 million tonnes of wheat this year, in addition to the 5.5 million tonnes imported last year.

As regards pulses, the major exporting countries have no large surplus and imports cannot be secured in the desired quantities advantageously. There is thus the peculiar phenomenon of imported inflation queering the pitch in some directions.

The monetary authorities have assumed that the average inflation rate will be around 5 per cent this year. GDP growth, however, is placed at 8.5 per cent against the earlier figure of 9 per cent.

A definite view for the current year can be taken only after a good monsoon in the kharif season and agricultural production rises by 3-4 per cent. It should also be ensured that industrial growth is sustained with adequate credit and resources in forex and rupees to fund expansion and new schemes involving heavy outlays.

Comfortable BOP

Thanks to rising export earnings and invisible receipts it has not been difficult to bridge the widening trade gap. As imports of crude and petro products are even now expensive and non-oil imports are increasing, the trade gap widened to $56.7 billion in April-March 2006-07 from $39.6 billion in 2005-06.

The current account deficit however was even marginally lower at $11.8 billion in April-December 2006 against $11.9 billion in the corresponding period of 2005, as invisible receipts increased to $40.5 billion from $28.1 billion.

The net rise is slightly more than the incremental trade gap.

Money market

The situation in the money market however is in complete contrast to the scene in the external sector. There is such an unsatisfied demand for credit that banks have had to utilise as much as 84.1 per cent of incremental deposits in the 12 months ended April 13, 2007 and effect only modest additions to investments in government and approved securities.

In the scramble for additional deposits, interest rates have been raised unexpectedly while lending rates too have had to be hiked to protect margins.

In view of recent developments and the RBI decision to lower the ceiling rate on deposits in external accounts, there is reason to believe that interest rates may not rise further from the present levels. Indeed, there may be a reversal of the uptrend if developments in the coming months on the farm front prove to be encouraging.

P. A. Seshan

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