By – S. Sethuraman ,31 July : Inflation has emerged as a global phenomenon in 2008 posing the biggest risk for the economies of both major industrial nations as well as the relatively faster-growing emerging market economies like India and other low-income developing countries.
It is a consequence of the continuous surge in international commodity prices, especially of crude oil whose prices were edging toward 145 dollars a barrel in July, more than double its 2007 average, as well as of food and basic metals.
Double-digit inflation now rages across several Asian and other developing economies, which are hard pressed in controlling prices through both monetary and supply-demand management measures. Governments are running bigger fiscal burdens in trying to enlarge the social security net for the poor. India’s current battle against the double digit inflation close to 12 per cent in July must be seen in this perspective.
Global institutions like the International Monetary Fund are telling nations that they must give the highest priority to fighting inflation, which had accelerated in leading developing countries including China and India, by tightening monetary policies and moderating demand.. The world economy is already slowing down in the midst of continuing financial turmoils, credit crunch and weakening business confidence. Over and above this, inflation has become a bigger danger for macro-economic stability.
Price pressures emerged in India at the beginning of 2008 mainly due to the soaring international oil and food prices. Between March and May, Government mounted an array of fiscal measures by slashing import and excise duties to help lower domestic price level. Administrative measures were taken to regulate exports including ban on non-basmati rice exports and steel items in order to improve domestic availability. These measures were expected to have a moderating impact in the following months.
However, according to revised data, the wholesale price index had already moved up to 7.75 per cent by the end of March 2008 as against the normal 4.5 to 5 per cent range, and since then inflation has been on an uptrend moving into double digit in June. The Reserve Bank of India has been gradually tightening its benchmark rates (interest and cash reserve ratios) in order to contain excessive liquidity and control growth in aggregate demand which exert upward pressures on prices.
The timely arrival of monsoon in June had raised hopes of bringing down the rate of inflation to some extent in the near future. However, unrelenting pressures of surge in international oil and food prices were raising inflation expectations everywhere. In June, Government were forced to effect what it called a moderate rise in petrol and diesel prices but the annual rate of inflation was already worryingly high at 8 per cent. The oil product price revision gave a boost to the headline inflation.
While food prices have somewhat eased in recent weeks with the record foodgrain production of 230 million tonnes in 2007-08, maximum wheat procurement at 22 million tonnes and rise in grain stocks at Government’s disposal, other basic food items have seen an uptrend. Government is trying to strengthen the public distribution system with imported edible oil at subsidised rates in order to help the low-income groups.
The overall outlook for prices continues to be one of serious concern and though there is some noticeable moderation in money supply and deposit accretion, non-food credit growth is higher on a year-to-year basis as on July 4. In combating inflation at the national level, the totality of the global situation and its possible spill-overs into emerging economies with all the risks on the downside have to be taken into account.
Faced with an “intolerable” level of inflation of close to 12 per cent, demand pressures and global commodity prices at elevated levels, the Reserve Bank of India further tightened its policy instruments on July 29 according high priority to price stability and anchoring inflation expectations.
The Repo Rate (the rate at which RBI lends to commercial banks) has been raised to 9 per cent with immediate effect, while leaving the bank rate and Reverse Repo Rates unchanged at 6 per cent. The Cash Reserve Ratio, which helps to impound a part of bank funds for controlling liquidity, has been increased by another quarter per cent to 9 per cent with effect from August 30. Both these rates had been revised in June in two phases to 8.5 per cent (Repo) and 8.75 per cent (CRR) respectively.
RBI had earlier given itself an objective of ensuring that inflation is kept around 5 to 5.5 per cent for an economy assumed to grow at 8 to 8.5 per cent in 2008-09. The developments since RBI announced its monetary and credit policy for the year on April 29 appear to rule out the prospects of higher growth with price stability in the current year. In view of the global slowdown, especially a decline in demand from USA, and global oil and food prices, IMF and the World Bank have lowered growth estimates for emerging economies and have projected growth for China and India at less than 10 and 8 per cent respectively in 2008.
The Reserve Bank has also revised down its earlier growth estimate to 8 per cent in 2008-09 if there are no further domestic or external shocks. While its policy actions are aimed at bringing down inflation to a tolerable level of 5 per cent, it feels the realistic endeavour at this juncture would be to lower it to close to 7 per cent by March 31, 2009 from the present 11-12 per cent range.
The Finance Ministry has welcomed the latest tightening of monetary policy and says it is a signal to banks for moderating credit growth, having regard to the need to moderate aggregate demand. Banks should be able to meet credit demands for productive sectors if loans are carefully appraised and credit is allocated prudently. Government expects all measures taken over the last two months including the Reserve Bank’s announcements on July 29 to help in moderating and containing inflation.
At the same time, RBI in its statement has also emphasized the importance of “close and careful” monitoring of fiscal developments in view of growing enhanced subsidy expenditures and off-budget liabilities (like bonds for oil companies), farmer loan waivers and salary revisions under the sixth pay commission report during the year. Increases in non-plan spending adds to demand pressures, apart from widening budget deficits.