The Hindu : Opinion / Editorials : INFLATION SURGES

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Monday, Aug 09, 2004

Opinion

Opinion - Editorials

INFLATION SURGES

THE RATE OF INFLATION announced on Friday is well above the top end of market expectations. The widely used measure for tracking inflation, the wholesale price index (WPI), has gone up to 7.51 per cent for the week ended July 24 — from 6.53 per cent the previous week. The surge has been blamed on increases in the prices of fruits and vegetables, food products, and iron ore, steel and metallic products. What is more worrying is that this sharp rise is even without factoring in global oil prices that seem set to go up to record levels. In fact, in an unhappy coincidence, the latest inflation figures were released on a day global oil prices soared to an all time high of $44.73 a barrel. Many experts are already discussing a $50 level as a distinct possibility in the not too distant future. In India, as in most countries, rising transportation fuel prices have been one of the principal causes of the resurgence in inflation. Ongoing efforts at mitigating the effects of the oil shocks will not be sufficient. The recently introduced price-band mechanism (which tempers the deleterious consequences of the oil shock on Indian consumers) might have been breached already and further price rises for petrol and diesel look unavoidable. Under the circumstances, it is difficult to share the optimism of the official spokesperson that inflation has peaked and can only come down. Even the revival of the monsoon might not be enough to check the price rises over the short run.

Official policy will now have to look at moderating inflationary expectations over a longer horizon and formulate adequate responses in between. The inflationary outlook for the current year, which the Reserve Bank of India pegged at 5 per cent in its annual policy statement of May, will have to be revised upwards. On top of the domestic factors fuelling inflation, the global signs are not encouraging. Along with petroleum products certain key commodities such as steel and coal have been in demand in the wake of a widespread global recovery and their prices are unlikely to come down. Clearly the time has come for the Government and the RBI to formulate an inflation containment strategy in line with global trends. Very recently, the Bank of England marked up the benchmark interest rates. The United States Federal Reserve has been pursuing, since July 2004, a strategy of increasing interest rates gradually.

Despite statements to the contrary, it seems a matter of time before authorities in India follow suit. There has been an awareness that the softer phase of the interest rate cycle has ended. Softer interest rates have, in the recent past, reduced the burden on the exchequer and helped borrowers save on interest costs. The first signs of the hardening of interest rates are already there. Home loans that spurred a boom in the housing sector have become costlier. Banks and housing finance companies have become wary of lending on a fixed rate basis. Bond markets in India seem to have factored in an interest rate increase: as yields on the long dated bonds increased, bond prices have come down sharply. By far the most significant impact of an interest rate increase will be on the Government's borrowing programme, which is budgeted at Rs.138,000 crores. Investors in bank deposits, who have already been getting negative returns, require urgent ameliorative measures. If the current inflation trends persist, there will be a strong case for re-examining issues connected with schemes that have a social security implication. There will be no justification for lowering the administered interest rates on Public Provident Fund, Employees' Provident Fund and similar schemes.

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