India - Inflation not the only concern

The sharp fall in inflation to 8.98 per cent for the week ended November 1 from 10.72 per cent a week earlier was unanticipated. While all forecasts had pointed to a lower inflation in the coming months, it was expected that the moderation would be more gradual. The Wholesale Price Index that measures inflation has been persistently above 10 per cent since the third week of May. However, a combination of propitious factors has accelerated the fall. Monsoons have been favou rable this year and agricultural production has been satisfactory. The steep fall in oil and other commodity prices in the global markets has been the most significant factor. Even granting that there could be temporary spikes, it is very likely that the RBI’s revised target of 7 per cent inflation by the end of the year would be achieved. Incidentally, the monetary policy’s comfort zone for inflation was between 5 and 5.5 per cent and even that seems within reach. There is a belief that inflation has ceased to be a major area of concern, making it possible for monetary policy to focus exclusively on arresting the slowdown in the economy. The RBI has since October effected rate cuts and pumped in enormous amounts of liquidity. In the wake of a distinctly lower inflation, the question arises whether it will effect even more massive cuts.

For the common man, however, more relevant than the WPI are the monthly consumer price indices, which show that the prices of essential commodities of day-to-day use have not come down. The fall in the WPI inflation is due to the slackening of consumer demand which has affected sectors such as construction and real estate. The IMF has forecast a global recession next year. Demand from global markets is therefore expected to be lower. The chairmen of many leading public sector banks say that liquidity is not an immediate concern. The possibility of accumulating bad loans as the economy slows down is, however, real and it has enhanced the traditional risk-aversion of government-owned banks. As solvency issues come to the fore, it is no longer a question of credit availability but credit delivery. Risk-averse banks are increasingly investing in government securities. Making public sector banks overcome their risk-aversion has been a challenging task in the past. At a time of global and domestic slowdown, it is unlikely that monetary measures alone will induce them to lend more. The fall in the WPI, while welcome, should not detract from the immediate task of arresting the slowdown.