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A more nuanced approach needed

The recent softening in the official inflation figures ought not to induce a sense of complacency on the part of either the Reserve Bank or the Finance Ministry. For two weeks in a row, the inflation rate as measured by the wholesale price index (WPI) has been below the 6 per cent mark — 5.66 per cent for the week ended April 28, 2007, and 5.77 per cent for the previous week. The price rise in the primary articles group that was marked during the later part of last year has not abated. Supply side pressures have kept the prices of wheat, pulses, fruits, and milk at a high level. Several ameliorative measures undertaken by the government to increase domestic supply of these items have had a limited impact. Consequently, policy makers are countering inflation from the demand side as well. A slew of monetary initiatives by the RBI have raised the cost of credit and targeted sectors such as real estate where there are signs of overheating. Despite all these, inflation, though down from its peak of 6.7 per cent in January this year, continues to be a major cause for worry. In its recent annual credit policy statements, the central bank reiterated its commitment to price stability. As against last year's inflation target of 5 to 5.5 per cent, it is setting an even more ambitious target of 4 to 4.5 per cent, albeit over the medium term.

At the current juncture inflation is a multi-faceted problem. A single line of attack therefore will not suffice and can in fact be counterproductive. An obvious example is the dilemma the RBI faces over its exchange rate policy in the larger context of containing inflation. Foreign capital inflows into the stock markets continue unabated. The RBI has had to moderate its interventionist approach that involved, in the first instance, purchase of dollars by following it up with an operation to mop up the rupees released into the system. The costs involved in this two-way operation have no doubt mattered but the consequences of its earlier inaction are being felt across the macroeconomy. The rupee has appreciated sharply against the dollar and there are indications already that significant sections of the economy, notably exporters, are getting adversely affected. It also needs to be realised that monetary measures to combat inflation operate with a lag of 12 to 18 months. Secondly, more scientific benchmarks for measuring inflation such as a three-year average over a specified period are needed. At another level, policy-makers as well as the common man will benefit from the harmonisation of the several types of consumer price indices.

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