The inflation rate of 9% for March-end has indeed caused a big scare that the generalised increase in prices may be getting horribly out of control. Until a few months ago, both North Block and RBI seemed optimistic that the inflation curve, even if showing a \rising trend, was much flatter during 2010-11 as compared with 2009-10.
Until February this year, the general discourse at the Planning Commission and finance ministry was that the inflation rate would trend somewhat downward in 2011 as the worst was over. In their anxiety to lower inflation expectations the officialdom had been predicting a much lower inflation rate by end-March 2011. Prime Minister Manmohan Singh, who is known to have sleepless nights over the issue of price rise, was repeatedly told by experts within the government that the inflation rate would be no more than 7.5% by March-end. He was also assured that the worst was over and that 2011-12 will see a more moderate rate of growth in prices. It is perhaps based on this assessment that the Union Budget also assumes a GDP growth of close to 9% with the inflation rate at 6-6.5%.
All these assumptions are now going awry as the inflation rate is showing unusual stickiness at around 8% levels. RBI has admitted that the food price inflation was first cyclical and is now structural in nature.
However, until late last year, the manufacturing price increase seemed to stay at moderate levels and this was seen as a silver lining of sorts. Now, manufacturing prices are also climbing up furiously on the back of rising global commodity prices.
It is interesting to note that even if Manmohan Singh?an economist by training?worries a lot about inflation, the political class seems to be more sanguine about it. Many senior Congress leaders argue that inflation was not such a dominant issue in any of the elections since 2009 when the UPA-2 came to power. Some senior Congress leaders argue that higher inflation is not damaging if people?s incomes also go up substantially. A few weeks ago, finance minister Pranab Mukherjee also suggested that some degree of inflation may be a price one has to pay for sustaining high growth.
This has been officially sanctified by his Chief Economic Advisor, Kaushik Basu, who has stated in the Economic Survey that higher inflation is a natural phenomenon that occurs as emerging market incomes catch up rapidly with those of the developed economies. It will be interesting to find out what Prime Minister Manmohan Singh thinks about the Kaushik Basu formulation.
I reckon Manmohan Singh would be very uncomfortable with the new discourse that some extra inflation could be tolerated purely to sustain higher growth.
Some argue that RBI had been somewhat lulled into complacency in its fight to contain inflation precisely because of the post facto political rationalisation in New Delhi, which treated higher inflation as a fallout of higher incomes and relative prosperity among the people.
My sense is RBI had been acutely aware of the pitfalls of the new discourse in New Delhi but had adopted a calibrated approach to raising interest rates mainly because global growth recovery had been quite uncertain throughout 2010. Many of the global risk factors such as sticky unemployment in the US and sovereign debt cum banking crises in Europe are still alive. To these have been added the political turmoil in the Middle East and the natural calamities in Japan, which are making global oil prices more sticky than ever.
Higher oil and commodity prices will sooner or later feed into domestic prices even if the government tries to suppress oil prices through subsidies. The point is, emerging market central bankers around the world are necessarily behind the curve as they are overwhelmed by global liquidity driving up commodity prices and creating long-term asset bubbles, such as in the real estate sector.
Last month, a senior European Union negotiator at the G-20 said they were seriously looking at the commodity bubble build up globally, especially with regard to food prices. He said speculative volumes in wheat in the international futures market was at 30 times the actual global production. He suggested this was unsustainable. The same may hold true for some other commodities, including oil.
What can a central banker do in the face of such a build up of asset bubbles globally. Monetary policy is only partially a sovereign function that central banks can use to control domestic prices. In the first round of asset bubble build up between 2005 and 2008, no central banker could predict the precipitous fall of economies after September 2008. They were all raising interest rates furiously to avoid overheating of their respective economies.
A similar pattern seems to be repeating with more risk factors embedded in the global economic system. As RBI prepares to make its important monetary policy statement next week, the key question that it will have to answer is?what is the economy?s potential output that can be achieved with moderate inflation? A GDP growth of 9% with 8% inflation is an impossible combination to sustain. Certainly not with the current level of reforms (or the abject lack of it) in the factor markets as well as the product markets. The UPA government has committed a huge error in taking for granted a 9% GDP growth. A totally new framework of reforms is needed to deal with emerging global headwinds. Is the UPA up to it?
mk.venu@expressindia.com
