Fiscal 2007-08 is not over yet. So, it is not inconceivable that the point-to-point inflation rate will moderate to something close to 5% by then. But we should look at the average inflation rate over the entire year instead. Though it is not the best of measures to track price trends, it would give a more comprehensive picture of price movements during 2007-08 than the point-to-point rate, which measures a price index at a particular point in the calendar with the figure exactly a year earlier. Even back then, it was easily foreseeable that the double impact of a spike in commodity prices and money supply would push inflation up this fiscal. A significant role was played by India?s stubborn exchange rate control mechanism, through which we have imported inflation, instead of letting the global reign of low interest rates relieve the price pressure at home. The RBI stepped in to buy dollars to moderate the rupee?s rise on account of excessive capital inflows from abroad, but its sterilisation of the excess rupees given out in the process has left the economy flush with liquidity, which has scuppered efforts to tame prices. The government, too, has done precious little to ease supply constraints on the movement of commodities, especially agricultural commodities from farmgates to shopshelves. According to the food processing ministry?s data, the food supply chain sees about Rs 60,000 crore wasted annually.
The big issue now is interest rates. Over the past few years, the cash surplus built up by industry had insulated it from the vagaries of interest rates, but that picture has changed. The central bank is clearly worried about inflation, but it need not read the rising rates on this score as a goodbye to any rate cut. The perceived slowdown of the manufacturing engine can be corrected through softer interest rates. Despite inflation hardening and the need for a positive real rate of interest to avoid a classic liquidity trap, there is still a window that could be used productively. At the retail end, the latest 5.92% WPI-based inflation rate may not be a trend indicator. But inflation above 5% means the worst affected would be those dependant on small savings. The rate of interest on these instruments is fractionally lower than 8%, which means their real rate of return is under 3%.
