Controlling inflation without hurting growth

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Ashok Handoo | 13 Aug, 2008
Has the inflation peaked in India? Well, if the international credit rating agency Moody is to be believed it "may have."

But there is no occasion to be euphoric as, it says, the internal situation will continue to be difficult for some time. That explains why both the Central government and the Reserve Bank of India continue to be firm in dealing with both the supply side and the liquidity side.

When the RBI recently raised the Repo Rate (the rate at which it lends money to the banks) by 50 basis points and the Cash Reserve Ratio, CRR, (the percentage of money that the banks are mandatorily required to keep with the Reserve Bank) by 25 basis points- taking it to as much as 9 percent -many of us did not like it because it in turn led to further increase in the already high interest rates. But if the bull of rising inflation, which has crossed the psychological barrier of 12 percent, has to be taken by its horns, drastic steps can not be avoided. The prescription is to reduce liquidity through monetary measures on the one hand and increase the supply of goods on the other, through fiscal and other measures.

Money supply in the country has been increasing at the rate of 20 percent a year, consistently for the last 3 years. This in turn leads to increase in demand for goods and commodities which forces the prices to go up. Thus, the need for curbing money supply for the time being.

But the real thrust has to be on the supply side because unless we increase the supply of goods, the always existing demand will keep on pushing the prices upwards. Besides, restricting the flow of funds beyond a point is bound to affect the growth rate as well. Already, economists have started admitting that the hard steps being taken by the government to tackle inflation will reduce the growth rate this year to some extent. But this may still hover around 7.5 to 8 percent against the backdrop of 9.1 percent growth the country witnessed last year.

It is in this background that the Prime Minister during the recent debate in Parliament emphasized that the government’s two top priorities are tackling inflation without hurting growth and revitalizing the farm sector to increase the agricultural output.

One of the latest economists to join those predicting an early control on inflation is the Planning Commission Deputy Chairman Shri Montek Singh Ahluwalia. He believes that the inflation rate will come down to single digit in a few months The RBI puts it at 7 percent by the end of this fiscal. Shri C Rangarajan, who has just resigned as Chairman of the Prime Minister’s Economic Advisory Council, believes it may be in the range of 8 to 9 percent by the year end.

Perhaps what makes them optimistic is the hope of a good monsoon this year that can boost agricultural production. Despite it being erratic in July and below average in critical states like Gujarat, Maharashtra and Andhra Pradesh, which could affect the production of ground nuts and cotton prices, it is expected to pick up in the current month. The falling crude oil prices, which have already come down to $118 per barrel from $143 a barrel only a few weeks ago is another indication of better days ahead. The international crude prices are expected to fall further due to moderation of demand in the developed countries, increase in the value of dollar and pressures from the developing countries that speculators should not be allowed to raise oil prices artificially. If the Monsoon really behaves and oil prices continue to fall to a reasonable level the country can make a turn around on the inflation front.

As a short term measure, the government has already banned the export of sensitive commodities like cement and non-basmati rice and reduced substantially import duties on a number of other commodities like steel, cement, pulses and other goods to increase their domestic supply. The cost of inputs has also been reduced to help the farmers grow more. There is however a limit to which the government can go in reducing duties. Beyond that point, reduction of duties can be counter-productive since loss of revenue can lead to fiscal deficit and consequently inflation. The government has also persuaded steel manufacturers to keep the prices of steel in check as it is a key component in the list of commodities that determine the wholesale price index.

The Government did well in deferring the decision on decontrolling sugar. It is widely believed that despite a good stocks position of 110 lakh tonnes and an expected good sugarcane crop this year, decontrolling it would lead to increase in its price. In the previous two years also successive glut in sugarcane crop could not prevent increase in sugar prices as the demand always outstrips its supply.

The government also plans to boost the flow of essential commodities by strengthening the state-run agencies and consumer federations. It will involve providing non- plan assistance to these agencies subject to certain eligibility conditions.

Thus while inflation continues to be a major concern there are indications to have almost peaked and would begin to subside in a few months. How soon can that happen will depend on how merciful is the rain God, how international crude oil prices behave and how good is the agriculture production in the country.

* The author is a freelance journalist

Disclaimer: The views expressed by the author in this feature are entirely his own and do not necessarily reflect the views of SME Times or its employees