The three-year-high inflation rate of 7.5% has sent shock waves all over the country and the danger of "high fuel inflation" rearing its head again is also more or less inevitable. C. S. MIRCHANDANI believes that it’s not yet time to panic but certainly it’s time to worry.

THE 7.5% RATE of inflation as measured at the end of July has shaken us all and caught the government off guard. Several contradictory noises are emanating from the supposedly knowledgeable. The Reserve Bank of India Governor, Y V Reddy, admitted that the July inflation rate, which touched a three-year high, was higher than what the monetary policy announced in May ’04 had visualized. Mr. Reddy has attributed a significant portion of the hike in inflation to “imported price shock, though some amount of upswing in prices was expected during the period.” “We will respond to developments on an ongoing basis with a view to maintaining price stability over the year,” he said. Former RBI governor, C Rangarajan, who is the Chairman of the Twelfth Finance Commission has said the real rates of interest - that is nominal rate of interest adjusted for inflation in the economy - should rise, as they have now turned negative. Earlier, the chief economic advisor, Mr. Ashok Lahiri had, responding to the 6.52% figure for 17 th July, said that inflation had peaked.

With the Finance Minister announcing that steps will be taken to reduce the impact of oil prices on inflation, any expectation of a further hike in administered price of crude products is ruled out in the immediate future. This means the price impact of crude imports will be borne by the government and could have an impact on the fiscal deficit, once again fuelling inflation.

SOARING! The rise in price of fuel products is almost inevitable.

But 7.5% may be only the beginning. The danger of high fuel inflation rearing its head again is also more or less inevitable. Next week’s inflation will factor in rises in petrol prices that took place on July 31. Given the fact that fuel inflation goes hand in hand with manufactured products inflation, a rise in the latter category is expected as well. Besides this rate is based on prices at the farm/ factory and doesn’t tell the full story. If one looks at prices at the local sabziwallah, the prices seem to have gone through the roof. Potatoes, tomatoes and onions are retailing at 35% above their wholesale price. Also there is no weightage for services, which now account for half our GDP and have been subjected to high taxes this year.

The oil price is likely to remain high with countries like China and, to a lesser extent, India on a high growth trajectory, the US economy reviving OPEC is left with little scope for increased production and Iraqi production gas been reduced by the ongoing turmoil. Similarly political compulsions may force an increase in agricultural procurement prices.

Remedial measures
SO, WHAT steps can we expect the FM to take? The traditional response to inflation is to reduce money supply, but with the huge surplus of funds in the banking sector this may not be feasible in the medium term. In any case, at a stage in our development when we are looking for a greater than 6% GDP growth, a choking of money supply could be counterproductive with high interest rates leading to the disaster of stagflation. Besides, if the main culprit is high commodity prices—iron ore demand has caused the price to more than double; oil prices are at an all time high, the poor monsoon and reduced buffer stocks leading to a rise in food prices- reducing liquidity to the corporate sector is not a sensible solution.

In a bid to soften the impact of crude prices, oil subsidies, which were to be totally withdrawn in ‘04-05, could go up further or the import tariffs may be lowered.

Of course, in the short term, interest rates on small savings may have to be raised. Investors in small savings are the most stable source of funds. The first positive benefit for the salaried classes could and should be a deferring of the move to lower interest on the PPF and industry does need to pay slightly higher interest. Blue chip corporates are today borrowing at close to nil real interest. As Mr. Rangarajan said, the real rates of interest in developing countries like India should not be the same as in the more developed countries. “Also, real rates of interest in a country which wants to grow at 7-8% per annum must necessarily be higher than countries which treat 2.5-3% as potential.” While nominal interest rates must move in tandem with inflation, it is necessary to have a view on the appropriate level of real rates on deposits and loans. They must have a relationship to the expected rate of growth of the economy”

But while the government agonises over its next step, what can those dependent on savings do? No fixed income securities will prevent the erosion of buying- power that this inflation causes. One will probably have to take a closer look at equities, which can be dangerous or fall back on the old favourites of gold and real estate. For those who are still earning, the sensible thing to do is consume! The car or refrigerator you were planning to buy tomorrow should be bought today. This may sound rash but there’s no other way to prevent an erosion in the value of your savings.

Rays of Hope
THERE ARE some rays of hope though. The 7.5% is arrived at on a very low base of July last year and come September the annual figure may look better. The Chinese economy may be heading towards a soft landing and international speculators may be forced to reduce oil prices. Similarly many other commodity prices may fall. Food prices may ease if the monsoon deficit is made up and if the monsoons continue to be poor, the demand push should reduce. Thus it’s not yet time to panic but certainly it’s time to worry.

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