Plot still lost on inflation

RBI should get single-minded in its policy

Despite sporting the A-team of economic managers, the government continues to fight inflation more with hope than tangible measures. The rabi harvest was expected to do the trick by now, but while some food prices (sugar, lentils, etc.) have fallen, the over-all rate of inflation remains stubbornly high. Now, hope is being placed on a normal monsoon, as forecast by the Met department, but the Met almost always predicts a normal monsoon and, therefore, has a poor record of predicting deviations from the norm. In other words, the forecast does not mean very much. To be sure, headline inflation rates have started dropping, but the “core” inflation rate (i.e., not counting food and fuel prices) has gone up in the last six months. Finally, there is the subsidy on oil products, which is soaring well beyond the modest limits provided in the Budget, even as Reliance chairman Mukesh Ambani forecasts that oil will climb to $100 per barrel — a 20-25 per cent increase on current rates. In short, the inflation beast has not been slain. It still has life in it. As much can be gauged from the somewhat tentative assessment of the chief economic adviser in the finance ministry, who says the inflation rate will fluctuate till July, after which it will come down.

What is to be done? The Reserve Bank so far has been behind the curve on the price problem, and has taken only hesitant half-steps. The gentle liquidity squeeze and modest interest rate hike announced at the last policy review have had no effect, because long-term interest rates on government bonds remain where they were (having reversed a brief rally), and short-term bank rates have not moved. The central bank should be more single-minded at its next policy review, especially since it expects a flood of capital inflows this year which can only add to the liquidity surplus in the system.

Similarly, the food minister talks of overflowing granaries but has not undertaken what the chairman of the Prime Minister’s Economic Advisory Council recommended in December: open market sales to give a supply shock to the system and dampen price expectations. This will mean a loss to the government and, therefore, an increase in the food subsidy, but that is a consequence of the government’s poor management of the food economy. In the short term, all instruments are fair game, be it liquidity tightening, rate hikes, prudential risk weights on real estate loans, or under-selling by the Food Corporation of India. In the longer term, of course, productivity increases and more broad-based growth are the only effective antidotes to the inflation virus.