Hobson's choice

Despite its best efforts at keeping prices down, the government is faced with an inflation fire that refuses to die out. The inflation rate based on the wholesale price index shot up to a 13-month high of 6.68 per cent for the week ended March 15. Then, there have been ominous signs over the last few weeks that the growth engine—and, in particular, industrial and infrastructure sector growth rates—is slowing down.

The two trends together conjure up the spectre of a period of high inflation and slowing growth. Of the two, the former is likely to occupy the government and the central bank more. Prime Minister Manmohan Singh, Finance Minister P. Chidambaram and RBI Governor Y.V. Reddy have all said so, in so many words.

But the authorities are fast running out of soft options. RBI’s annual credit policy announcement is due on April 29, and it is widely expected that inflationary pressures will force the central bank to hold key rates and, maybe, even increase the Cash Reserve Ratio, to suck some more liquidity out of the system. Reddy had held on to rates in the previous quarterly review in January-end despite the US Federal Reserve slashing interest rates. But this course of action is now a little more complicated than it was in the past.

For one, this time around, the inflation is not demand-led and, hence, not so easily amenable to monetary tools. The main contributors to inflation over the past six months have been fuel, metals and edible oils & oil seeds. These commodity prices, influenced as they are by global prices, will ease only when the threat of a global economic slowdown becomes real and demand slackens. That’s a long-drawn-out process.

For another, continuing with higher rates will keep the interest rate arbitrage window between the developed economies and India open for some more time, and lead to more foreign funds inflows, which, in turn, will push the rupee higher against the dollar. Exporters, already smarting from last year’s 12 per cent appreciation, will be impacted even further. However, given the political imperatives—10 Assembly elections and the General Elections are due over the next 13 months—RBI’s options are limited.

It is a Hobson’s choice for both the government and the central bank. But some good may yet come out of this mini-crisis. Tough times have forced governments in the past to press ahead with the reform agenda. Maybe this one will, too.