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The dark side of fighting inflation

Much of the current inflation spike is supply side linked or imported and cutting duties is the right way to go, writes Udayan Mukherjee.

business Updated: Apr 01, 2008 20:49 IST
Udayan Mukherjee
Udayan Mukherjee
Hindustan Times

Inflation hitting 7 per cent in a pre-election year is just the kind of stuff that makes governments panic. The thing about panic is that people stop behaving rationally or intelligently, poor decisions are taken. I fear we will see some knee-jerk policy action that will not be very clever, in this round of inflation fighting too.

There is no argument with the government's moves to cut duties or take steps to ease supply constraints. Much of the current inflation spike is supply side linked or imported. Cutting duties is the right way to go. If there is any evidence that commodity producers are creating an artificial scarcity scenario in the domestic market because of disproportionately high exports, that too could be controlled with some policy curbs. Yet, a line needs to be drawn.

In telling commodity producers to "cut" prices, the government may be overstepping that line. No one likes high inflation and, yes, all of us feel for the poor who have to shell out more for essential food items. That is not the same thing though as telling a steel company to cut prices or an iron ore company to give a 20 per cent discount to a buyer.
That is administered pricing, of which the government has very rich experience. Sadly, that may turn out to be the reality for many industrial commodity manufacturers this year.

The government is extremely unlikely to let them hike prices till inflation cools off. That may be in the larger national interest or the government's political interest but it certainly is not fair economics. What would be worse is the government leaning on the RBI or the central bank overreacting anyway with stiff monetary tightening. The RBI will be aware of the limited impact higher interest rates could have on this particular type of inflation yet it may want to be "seen" as doing everything necessary to fight the inflation devil.

In any case, it is wishful to think that the finance ministry will not co-opt the RBI in its battle against Inflation.

Also, do not think that policy-makers will hesitate to tighten policy out of considerations of stifling growth. Growth may be loved by global businessmen and investors but they do not vote. High prices can lose elections for governments in power.

From a stock market investor's point of view all this is extremely material. It is not just an armchair economic debate. Inflation-countering moves can certainly affect earnings and, more importantly, perception and sentiment for a whole host of sectors like steel, iron ore, cement, banking and real estate.

Yes, overreaction can present opportunities too, but it is prudent to keep all this in mind as inflation and the fight against it will be a dominant theme for our economy in the months to come.