With inflation hovering at a three-year high of 7% for the week ending March 22, experts feel that the spurt is driven by supply-side bottlenecks in agriculture and increase in prices of steel and cement. They however feel that the spurt could be contained by some tight monetary measures, but if it still persists then there will be enough reasons for the economy to slowdown and the corporate sector will be hit hard.

Inflation rate has doubled in just a few months time, much beyond the 5% target of the Reserve Bank of India. RS Subramanian, managing director, Subhishka Trading Services, says the current spurt in inflation is purely supply-led, which is primarily impacting food items and staples. ?Since the basic consumption of staples can?t change, savings and discretionary consumption will be hit?be it scooters, motorcycles, durables or mobiles.?

He, however, explains that domestic consumption will remain strong because of high salaries and lower taxes, but with high interest rates on loans the purchase of consumer durables may take a hit. ?Investment by corporates will be impacted more by money tightness, induced by weaker equity and global correction than by inflation,? he says.

Rupa Rege Nitsure, chief economist, Bank of Baroda, feels that inflation has accelerated to this level due to persistent upward pressure in the prices of primary articles like key foodgrains, edible oils and also due to high prices of manufactured products like fuels and metals. ?Continued M3 expansion over and above the RBI?s targeted level has also contributed to the upward bias in prices,? she says.

India is an inflation-sensitive nation. In the 1970s the country had 8% inflation, but GDP growth was only 3.5%. In the 1980s and 1990s, though GDP growth was 5%, inflation was around 9% and it dipped to 4% a couple of years ago and GDP grew to 8%.

Experts say there is a well established and empirically proved inverse relationship between inflation and long-term growth. High level of inflation would stimulate monetary tightening, resulting in hardening of interest rates, which in turn would slowdown investment spending by the corporate sector. Also direct intervention in the price setting processes of certain industries like steel does not augur well for the profitability of such industries.

Richard Rekhy, chief operating officer, KPMG, a global tax consultancy firm, says a higher degree of uncertainty and variability of inflation would reduce the efficiency of investment for the corporate sector. ?Moderate inflation can be expected in a economy that is growing fast, but if it persists for a longer time companies may have to pass the burden of rising input costs on to the consumers.? He adds, ?With high disposable incomes, a part of the burden can be passed on to the consumer but beyond the tolerance level, consumers will defer their purchases especially in the case of consumer durables and automobiles which will affect the revenues of companies.?

Does that mean that companies have to gear up for higher inflationary trends in the future? Subramanian feels that companies in India will have to squeeze supply chain and cut costs. ?Companies have to adjust forecast by aligning to changed demand pattern and focus on value and not frills in communicating with consumers,? he says.

Rupa says that companies should adopt measures to reduce those cost components over which they have better control and improve efficiency gains. ?Companies must improve various aspects of their business processes by streamlining operations, eliminating redundancies and other methods.? She further adds, ?In the present global environment, they also need to watch carefully the currency movements and appropriately hedge their forex exposures. Export-oriented companies should make an active effort to diversify their export destinations to East Asia, Middle East and Africa where economic slowdown is not severe.?

With the drying up of the capital markets and lack of funds from global sources, the high cost of bank finance is becoming a concern for the industry. So, will high inflation mar capital expansion plans of corporate India? Rekhy feels that with the current inflation rate the expansion plans of companies will not take a hit. ?But if further monetary measures are taken, raising capital from the domestic market would be difficult. This might create problem for corporates mulling capital expansion plans in the future.? Agrees Subramanian, ?More than inflation, we will suffer from money tightening, as a global phenomenon.?

High inflation, Rupa explains, would give rise to high interest rates and this would mar the expansion plans of those companies that do not enjoy the backing of good internal earnings. ?These will be primarily from the SME sector. Large corporates will show a better shock absorption capacity to high interest rates. Also, they have easy access to domestic and overseas capital/bond markets.?

The data also shows that the manufacturing sector growth responds inversely to changes in real interest rates. The growth in the manufacturing sector output which has almost 80% weight in IIP, declined to 5.9% in January, against 12.3% in the same month last year. This is a repeat of the mid- nineties when similar tight monetary policy situation led to a severe deceleration of manufacturing sector. Overall industrial growth decelerated to 7.1% in 1996-97 from 11.3% in 1995-96 and further declined to 4.6% in 1997-98.

The upturn started only about three years ago, but in the last two quarters, the manufacturing sector witnessed a slowdown because of negative growth of consumer durables.

Higher inflation will not just hit the manufacturing sector, but even banks may be affected. As they have seen record loan growth during the last few years, they have a major challenge on hand as an imminent interest rate hike may slow down their loan growth.

Meanwhile, the government has reduced duties on a number of items like edible oil to lower their prices. But

Subramanian feels that are no short-term fixes to control inflation, improving the supply situation like agricultureproductivity would be a more durable solution for this problem.