High growth does not warrant higher inflation: EAC

A high growth of the economy does not warrant high levels of inflation, and past experience has been that inflation in foodgrain and vegetable prices have resulted in inflation across other sectors, said C Rangarajan, chairman, Economic Advisory Council to the Prime Minister.

In his address on ‘Perspectives on Growth and Inflation in India’, at an event jointly organised by the Reserve Bank Staff College and the Madras School of Economics, he said the government is committed to maintaining inflation at low levels using policy instruments, including intervention in the grain market, fiscal and monetary policy, to bring down the present inflation rate and re-anchor inflationary expectations to the 4-5 per cent comfort zone.

“While the food price inflation of the past year was triggered by the rise in foodgrain prices, this year it has been triggered by the rise in the prices of vegetables, fruits, eggs, meat and fish,” said Rangarajan.

“It is argued by some that high growth warrants high inflation. The extraordinarily high levels of inflation seen in the last two years is due to certain supply constraints, particularly of agriculture products,” he added.

In 2009-10, the foodgrain production declined 11 million tonnes due to the deficient monsoon which had triggered inflation as measured by the wholesale price index which touched a peak of 11 per cent in April 2010.

The inflation had started moderating in 2010-11, as expected, but only till November 2010.

However, prices started rising after that, and as of February, the year-on-year inflation was 8.3 per cent owing to the increase in vegetable prices due to the late rains affecting supply of some vegetables including onion.

“Last four weeks vegetable prices have shown a declining trend and inflation is expected to come down to 7.5 per cent by March 2011. Of course, we need to watch out for what happens to crude prices in the global markets,” said Rangarajan.

For instance, in the three years, from 2005-06 to 2007-08 when the Gross Domestic Product (GDP) growth rate exceeded 9 per cent, inflation rate was much lower.

The behaviour of prices also depends on the rate of increase in money supply. The one situation in which a high growth rate may result in higher inflation is when the growth rate exceeds potential capacity of the economy, in a situation called overheating, he added.

Indian economy has not been affected by overheating since the investment of the economy now exceeds 36 per cent and even with an incremental capital-output ratio of 4:1, the country should be able to grow comfortably at 9 per cent.

The threshold level for inflation, which shows the acceptable rise in prices, is regarded as 4 per cent, according to Chakravarty Committee. In the Indian context, inflation rate around 5-6 per cent may be acceptable.