The current level of inflation of 9% (which could go higher) is clearly unacceptable. We also need to accept that almost everybody has forecast incorrectly and therefore, by deduction, our remedies to achieve targeted inflation have not worked.
The most obvious casualty of a full on fight against inflation has to be growth. Any textbook on macroeconomic policy points out that there is a short-term trade-off between growth and price rise. Thus, to bring inflation down growth must moderate.
The RBI’s relentless increase in policy rates is quite clearly geared to slowing growth down. The budget targets for 2011–2012 ironically enough, are premised on 9% GDP growth, while experience tells us that any GDP growth beyond 8.5% leads to a spike in inflation.
The government’s reluctance to compromise on growth is perhaps understandable. Tax
revenues for one depend on growth and deceleration is likely to hurt this.
In short, acknowledging the possibility of lower growth would raise questions on fiscal targets. This would be aggravated by the probability of higher oil prices not being passed on. The policies would then
need to tackle the fiscal deficit on a war footing.
The question then is: Which is the lesser evil in this trade-off? — High inflation or unmet fiscal targets? At this stage, the choice should be clear. Inflation has to get priority. If the consequence is slippage in fiscal targets, we will all have to learn to live with it.
Nimble supply management through import or excise duty cuts could result in less revenue for government and higher fiscal ratios. This is the collateral damage of the battle with the price-line.
The writer is managing director, HDFC Bank