The consistency in inflation rates is worrying policy-makers

The stock markets are entering a gloomy second-half of 2011-12, notwithstanding a grim economic scenario globally. Is it a failure of the economic policy adopted by several nation states supporting their falling financial institutions? While this question is debatable among economists and policy-makers, the Indian conditions are peculiar compared to other developing nations, which have more exposure to developed markets while India is not. This statement goes with a caveat that India is not immune to global economic incidents.

The benchmark Bombay Stock Exchange (BSE) 30-share index, Sensex, recorded its biggest quarterly fall of 12.8 per cent as on September 30, 2011. Earlier, its biggest fall was recorded in the aftermath of the collapse of U.S.-based Lehman Brothers in September 2008, a 25 per cent downfall in the third quarter (October to December) in 2008. The Sensex closed at 16453.76 on September 30, 2011, against 19420.39 in April this year, a fall of 2966.63 points.

Meanwhile the rupee's fall was sharper and it moved towards the range of 49.50-50 in September as compared to an average of 44.30 a dollar in April. In calendar year 2008, the average of rupee's exchange rate was around 43.40 a dollar.

Whether these numbers indicate an imminent lack of confidence among market participants in the third quarter (October to December) of the current fiscal and a fall with the same dimension witnessed in 2008?

High inflation and lower growth rate were hampering the domestic market confidence. More than high inflation rates, the consistency in these rates and the resultant inflationary pressure were worrying policy-makers. When the Reserve Bank of India announced its monetary policy measures in the beginning of the current fiscal, it had a hope that the economic situation would have some clarity by end-September.

The Annual Policy for 2011-12 is set in conditions significantly different from those a year ago. There was a clear risk of food price pressures spilling over into more generalised inflation. The factors which have shaped the outlook and monetary strategy for 2011-12, as the RBI Governor stated, are still continuing. First, global commodity prices, which have surged in recent months are likely to remain firm, and may well increase further over the course of the year. This suggests that higher inflation will persist, and may indeed get worse. Second, headline and core inflation have significantly overshot even the most pessimistic projections over the past few months. This raises concern about inflation expectations becoming unhinged. Over the long run, high inflation is inimical to sustained growth as it harms investment by creating uncertainty.

Global uncertainty

The global uncertainty is continuing. The U.S. Federal Reserve's decision to extend the average maturity of its holdings of securities, known as Operation Twist failed to cheer markets. The U.S. markets as well as global markets were expecting some more stimulus measures from the largest economy of the world. While announcing these, the U.S. Fed forewarned that nothing is rosy (at least in the near future) for the global economy. However, some measures by Europeans would likely to fill some confidence gaps created by European Union member nations. The decision by Germany and Finland to enhance the powers of European Financial Stability Fund (EFSF)) would allow the fund to participate in the primary market and to recapitalise European banks. This will have a positive impact on the European markets. But a falling number of businesses in Europe and slowdown in China's manufacturing sector will have further negative impact on global markets.

The present global economic scenario is offering some redundant hopes to some market players. They believe that commodity prices are likely to see some softening as the global growth slows down, which would further ensure the domestic prices coming down. According to them, this may anchor expectations on inflation and interest rates in India.

The only silver-line left with India in the present global and domestic economic circumstances is economic reforms. Reforms are not a let-loose liberalisation. The Government is presently looking at reforms in various sectors. It has already made progress in this regard with the approval of the draft Land Acquisition, Rehabilitation and Resettlement Bill 2011 and the Mining Bill. These were some of the much needed reforms. Industry bodies already started their usual tantrums against these bills, which are likely to ensure an equitable society where businesses could thrive. Such reforms are needed to attract more foreign funds into the country. Markets will react positively when affirmative action on policy reforms will take place.

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