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Unrelenting inflation

In the third week of July, inflation climbed to 11.98 per cent. It may not have crossed the psychologically significant mark of 12 per cent but the fact that it has resumed its upward march after moderating slightly the previous week, though expected, is a cause for concern. Inflation may well move up further before coming down to single digit during the last quarter of this year. In its annual policy statement, the RBI hoped to contain inflation within a 5-5.5 per cent band. However given the surge since then and the factors underpinning it, the central bank has fixed a more realistic target of close to 7 per cent by March 31, 2009. In targeting inflation so emphatically — through stiff hikes in the repo rate and the CRR among others — the RBI is acknowledging that monetary policy has a very large role to play at this juncture. Especially in a context where supply side options are virtually exhausted, it has to be proactive in countering the demand side pressures and moderating inflationary expectations. Even the noticeable economic slowdown and the fact that past monetary tightening has started yielding results are not sufficient reasons to dilute the present monetary stance. Its preference for price stability over growth is not new but has become more pronounced now. Interest rates on home loans have gone up sharply very recently. Money supply has moderated although it is still above the target.

Inflation is a global phenomenon but with graver implications for the developing countries. The IMF has revised its inflation forecasts upward for developing countries including India, while marking down the growth estimates. Global crude prices might have come down by $15-20 from the peak level of $145 a barrel. However, despite recent increases in retail prices, Indian consumers pay much less than what global crude prices warrant. Crude prices are not expected to ease further in the near-term, given the tight demand-supply balance and the deteriorating geopolitical situation in some important oil producing regions. Food prices — especially of wheat, rice, corn, and edible oilseeds — are likely to remain high because of supply side constraints. Additionally, central government finances have come under strain on account of the award of the Sixth Pay Commission, higher oil and fertiliser subsidies, and the cost of farm loan waiver. Some of these feed demand side impulses that stoke inflation. The paucity of supply side solutions and the deteriorating fiscal situation have heightened inflationary expectations and explain the RBI’s single-minded effort to contain demand side pressures.

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