Random Thoughts

India's inflationary measures

The government’s attempt to get the best of both the worlds

The governor of the Reserve Bank of India is quite a busy man these days. The chief of the Central bank of one of the fastest growing emerging economies is doing some fire fighting to curtail inflationary trends in the economy which has been growing at a phenomenal pace in recent times.

But, unfortunately, the Indian central bank is not truly an independent institution in reality and has to consider political aspects and pressures while taking major decisions. Thus, the rising inflation --- measured by various parameters including rise in wholesale price index (WPI), price indices for urban nonmanual labour and agricultural labour --- for past few weeks has really upset the finance minister especially due to local elections in various states wherein rising inflation, even today, is considered as a failure of the government to control rising prices. This, in turn, has resulted in RBI's decision to hike benchmark interest rates and also the percentage of money banks have to maintain as cash. This serves the purpose of sucking excess cash in the system which makes demand run ahead of supply.

At the same time, the government is taking its own measures to bring down inflation by trying to artificially check increase in product prices. So, we have seen it slashing customs duties on various inputs and prices of transport fuels recently.

Now, this interference of the government in the market place seems to be reversing the kind of result the RBI wants to see. Basically, the central government sucks money from the system to curb the excess demand --- the demand in excess of supply, which drives prices up. If the government is trying to bring the prices down, the demand will not recede as expected by the RBI. And, this means, we are entering in a long mess wherein at one end the RBI will go on rising interest rates to curb demand, while the government's urge to bring prices down will keep the demand intact!!

This sounds weird. The government is trying to go in two different directions at the same time. It wants to curb inflation without seeing a drop in economic growth. Now, this is like trying to have the cake and eat it too!!

Labels: Policies

posted by Ranjit @ 2/18/2007 08:39:00 pm