There may be a consensus about the causes of the current runaway inflation, hovering around 11.89% as of June 28, up from 11.63% the previous week, but bankers and economists differ on the timing and effectiveness of some of the steps the policymakers have taken to check inflation.
Inflation has touched double digits despite the fact that Reserve Bank of India (RBI) had adopted tight monetary measures since 2004,as the economy appeared to be, to use a much-debated term, ?overheating?.
Of late, RBI has tightened money supply, while the government reduced customs duty on a number of raw materials. Besides, the government has allowed duty-free import of wheat and convinced cement and steel makers to hold prices for some time.
Some years ago, Montek Singh Ahluwalia, deputy chairman, Planning Commission, had said any extraordinary steps to contain inflation may prove counter-productive. ?One should not look for instant results and very quick steps may result in damages,? Ahluwalia had said about two years ago, when asked whether the economy was overheating.
Summing up the divergence between the ministry of finance and the RBI, DK Joshi, principal economist at rating agency Crisil says, till some time back, while the ministry of finance was trying to preserve 8-9% growth, RBI was making efforts to balance both growth and inflation.
?However, with double-digit inflation, things have changed. Both are now trying to douse the fire of inflation together,?? he adds. Joshi says the government should have gone for a more staggered rise in prices of petro-products instead of hiking it by 10% at one stroke.
?The government could have hiked petro-prices when inflation was at 4.5% and oil prices at $90 a barrel was putting pressure on inflation, he explains. He says despite the current round of tight monetary measures, growth during the year will still be around 7-8% and inflation will continue to be around 10% till March 2009. ?The growth rate will certainly fall next year,?? he predicts.
Experts admit there have been unanticipated global developments after January 2008.There has been a persistent rise in crude oil prices, commodities, and food prices, which have resulted in a dangerous cocktail, with inflationary pressures building up and economic growth decelerating. Globally, this has resulted in central banks? primary concerns shifting from growth to inflation risks, reflected in the recent comments of chiefs of some of the central banks. Central banks in developed economies, including the US Federal Reserve and European Central Bank, which cut interest rates and undertook liquidity infusion to ease the impact of the credit crisis earlier in the year, may now be planning to hike rates to control inflationary pressures.
Unlike developed countries, economies in the Asian and emerging markets space have consistently adopted a tight monetary stance to deal with rising inflation due to commodity and food prices on the back of relatively higher economic growth. Central banks in countries such as China, South Korea, Brazil, Mexico, South Africa, have been raising interest rates.
Central banks are now clear there is a ?structural transformation of the global economy?, and the discussion at the central banks? level now centres around how much upside bias there is to inflation. ?How much will it move on to other commodities, beyond oil, is the issue also being discussed globally,? a banker said. There is also a broad agreement at the central bankers? level globally that there is heightened uncertainty, perhaps more than that witnessed over the past thirty years. ?Clearly, the uncertainty is the highest in the US. The conversation in the US markets now centres around the fact that recession has not been witnessed there so far,? point out banking sources.
RBI has clearly indicated that aggregate demand pressures have been on the higher side, despite the monetary tightening and appears to be focussed on alleviating inflationary pressures. It has indicated that the key economic drivers ? investment and consumption, remain strong, contributing to increased demand. In such a scenario, global oil prices and inflationary pressures are likely to be the key factors for domestic monetary policy.
Over the near term, monetary policy is expected to retain a tightening bias and any change/pause in current policy direction will be dependent on inflation, say bankers.
?We expect liquidity to remain tight and despite the advance tax flows, the CRR hike along with RBI intervention in the forex markets, should remove any excess liquidity from the system. The increased differential between the repo/reverse repo rate is in line with the central bank?s stated policy of maintaining a wider band in uncertain times. Any unexpected increase in the government?s borrowing programme leading to higher bond issuances will impact the demand-supply scenario,?? says an analyst.
The latest inflation and industrial production figures point to the fact that what RBI governor Yaga Venugopal Reddy has called ?the new reality? at his June 23 speech in Pune, just after inflation hit double digits for the first time in recent years, is now going to be here for some time.
Says Sonal Varma of Lehman Brothers, ?The latest data suggest that the trade-off between rising inflation and falling growth is worsening. While growth continues to weaken, much of the slowdown has been confined to the industrial sector, with service sector output still chugging along. Between the hard choice of rising inflation and slowing growth, we expect the RBI to choose inflation. Risk of second-round inflation effects, such as producers passing on higher input costs and workers demanding higher wages due to rising cost of living, are rising.?
So what signal does one expect from Mint Road, when Reddy and his team meets to review the monetary policy for the first quarter, on July 29?
Says Varma, ?To contain inflation expectations, we expect the RBI to hike the repo rate by 25 basis points on July 29 and the CRR by 50 bps in Q32008, but we do not rule out a more aggressive 50 bps hike later this month. Ultimately, the only way to control supply-side inflation is by slowing demand and the May industrial report suggests that the demand slowdown may have already begun.?
Clearly, for RBI, the task at hand ? even as it grapples with the twin objectives of keeping growth from slowing precariously and managing inflationary expectations ? is to flag global uncertainties (crude heads dangerously close to $150 a barrel even as this piece is being written) and to devise means of making the new reality least painful and non-disruptive. The challenge for RBI just got tougher.