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The inflation puzzle

Economists in free market nations have to deal with puzzles that are far more complex than in state-dominated systems.

india Updated: Feb 20, 2007 16:20 IST

Economists in free market nations have to deal with puzzles that are far more complex than in state-dominated systems, where the dividing line between administration and economic management is thin. For India’s policy-makers, used to old mechanisms in dealing with inflation, the latest spike in the dreaded number offers a cumbersome jigsaw to resolve. Inflation measured by the wholesale price index has touched 6.58 per cent in the latest weekly data, while the Reserve Bank of India is targeting a 5 to 5.5 per cent limit. Higher inflation warrants higher interest rates, and this can raise manufacturing and borrowing costs in the economy, leading up to an eventual choking of the growth rate. Just when the economy was feeling like it was China, and even before the government could exult in two successive years of 9 per cent plus gross domestic product (GDP) growth, comes the warning on inflation. While that seems like a spoilsport statistic, perhaps the silver lining lies in the sobering effect that it must bring to our policy-makers.

India’s infrastructure is far below China’s levels, and the war on poverty is far from over. Incomes are rising with growth, and this is fuelling demand that can push up inflation. Agriculture needs a lot of nurturing still. Thus, while growth figures give room for optimism, the inflation number laces it with caution. The RBI has dutifully tightened money supply and made banks raise their deposit rates. The government has eased some import duties to lower the costs of goods flowing in from abroad. While these measures will have some salutary impact, it is wise to keep in mind global crude prices and the fact that the ‘pass through’ impact has not been passed on to Indian consumers yet.

In effect, the current rate of inflation, while not a cause for alarm, is definitely a matter for concern. Perhaps it is wise for policy-makers to bite the bullet with some tough measures and also keep in mind that a percentage point shaved off GDP growth is not a bad idea if that gives a more balanced edge to the economy. Food prices are of particular concern because they are politically and socially sensitive. Given the urgent need for political stability and a broadbased consensus on economic reforms, inflation management is top priority for reforms to move at a steady pace.