Focus on inflation

In a recent update of its World Economic Outlook, the International Monetary Fund has called upon developing countries to make the fight against inflation their top priority. While marking up inflation forecasts for these countries by more than 1.5 percentage points to 9.1 per cent in 2008 and 7.4 per cent in 2009, it urges central banks to tighten their monetary policies, and governments to exercise fiscal restraint. Unless these policies are pursued vigorously, there will be no moderation in inflation over the near-term. In addition to soaring commodity prices, the IMF cites “above- trend” economic growth in some of these countries and accommodative policies followed by their governments as the main factors behind the inflation. In developed countries, inflationary pressures are likely to meet with a fall in demand. In the European Union, fears of a sharp economic slowdown have overtaken the fears of inflation. Until recently, the European Central Bank has focussed on price stability. The U.S. Federal Reserve, having brought down the interest rates sharply, has not yet signalled a tightening presumably to forestall a full-blown recession.

The world over, policy makers are forced to balance the demands of economic growth and price stability. The IMF expects the world economy to slow down from 5 per cent last year to 4.1 per cent in 2008 and 3.9 per cent next year. Developing countries including India and China are widely expected to partially off-set the slowdown in the West. However, partly due to monetary tightening in the past, they are expected to grow at a slower 7 per cent in 2008-09, one percentage point less than in the previous year. In India, the WPI inflation has climbed to 11.91 per cent during the first week of July. There can be little consolation from the fact that the index increased only marginally over the previous week or that the prices of some food items have come down slightly. Global oil prices, despite their recent unexpected fall, are still on the high side. The secondary effects of the last hike in domestic petrol and diesel prices will take time to work their way through the system. The spatial distribution of the South-West monsoon has been uneven so far. Despite a record harvest, food prices are still very high. Citing some of these reasons, RBI Governor Y.V. Reddy has said that there is little likelihood of inflation coming down to single digits in the next six months. Hence some more monetary measures involving hikes in the CRR and the repo rate are strongly indicated, by July 29 when the RBI is due to review its monetary policy, or even earlier.

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