Given the inflation trends, however, this would be un-typical reaction of the RBI. The Reserve Bank, as the custodian of monetary policy in the country, has been raising interest rates for more than a year now to bring down inflation rates. Inflation trends have however proved to be defiant. According to latest figures, inflation reached 9.44% in June against 9.06% in May. At least the bankers are feeling another round of interest hike is unlikely to have any impact on the prices. Is there a sense of frustration about monetary corrective to inflationary price rise.

It has been repeated any number of times recently that the Reserve Bank has raised interest rates for the tenth time consecutively since March 2010. It would, in all likelihood, increase interest rates again for the eleventh time after the 26th July review. And inflation will keep rising or remain high in spite of that. The factors contributing to Indian inflation are deeper than mere monetary factors. On the one hand, food demand –or rather the changing pattern of food demand—is leaving its imprint on the prices. Secondly, food price rise is spilling over into the rest of the economy through say wage revisions. Thirdly, the high interest regime is discouraging investment in the creation of fresh capacity. This is resulting in higher input prices for industry and therefore in manufacturing inflation. Let us look in these.

While the wholesale price index is rising, more significantly, food inflation levels have increased faster by the last count. Food inflation has once again increased according to the latest release of the price figures to 8.31% in the week ending July 2 from 7.61% previous week. In the current week it has shown a wee bit fall. Onions, vegetables and fruit prices have rose sharply in May. Grain based inflation has been a thing of the past and grain prices – rice and wheat — have remained more or less stable. Thus, given the nature of the food inflation, it is not possible to counter such price rise by importing the items in short supply which are showing spike in prices.

It may be recalled that eminent agriculture scientist, Dr M.S. Swaminathan, had presented a detailed programme for development of horticulture, which included a plan for raising production of both vegetables and fruits, like a new Green Revolution for production of these items. Various studies confirm changes in nation’s dietary preferences, including one by the Reserve Bank. There is some consensus that the dietary patterns are changing and this is reflected in the concentrated price rise of vegetables. Hence, to check such price rise in the long term what we need is a food production revolution not just hikes in interest rates.

On the other hand, manufacturing sector prices are rising on the back of wage increases as well as following rise in the prices of a wide variety of industrial raw materials. This is coming out from the overall price indices. From primary raw materials to industrial intermediaries, prices are rising. Thus, the prices of non-food primary articles, which are mainly industrial raw materials like fibres (cotton or jute) and minerals are showing strong inflation trend. Minerals prices are rising by nearly 28% and those of fibres by 34%.

The reason these prices are rising is because while Indian economy has grown rapidly, capacity in the upstream industries have not increased in step. One reason why this is happening is that the high interest costs are discouraging fresh investment in capacity creation. Upstream industries like mining and minerals production or extraction of oil or gas, coal mining are typically investment intensive and have long gestation period. Continuing hikes in interest rates are discouraging these industries from taking up fresh investment commitment. The union finance ministry has admitted as much in its review of the economy released this week.

The financial reasons apart, one must of course admit that other barriers like hitches over environmental clearances or land acquisition have come in the way of such investment. No new coal mine for example has been opened, despite the fact that the country is facing coal shortages. Steel plants to power stations have complained of shortages of coal holding up their steel production or power generation. The extent to which fresh investment has fallen can be gauged from the fact that gross capital formation (GCF) has fallen from 17% in the first quarter to nearly “zero” in the last quarter. The bankers have pointedly observed that when industries are operating at full capacity, hikes interest rates would discourage investment in fresh capacity creation.

No wonder that the government is toning down its expectations of an upbeat economy. While presenting his budget, union finance minister, Pranab Mukherjee, had expressed his confidence about hitting 9% growth rate and the twelfth plan was being crafted with an underlying growth rate of 10%. For the present year, government has already pared growth rate to 8.6%. Even that now looks a little ambitious. For all you know, the economy might grow by a more modest 7.5% to 8%. Reserve Bank is now saying these dips in growth performance are by way of cyclical trends. Not to worry. Hopefully, it should be so.

However, it is time to recognize some structural changes undergoing in the economy and respond to these well in time. In the coming decade, it should be the performance of the farm sector that will give direction to the overall economy. We are not yet free from the agricultural rhythm. Food demand is outstripping the domestic supplies. It would be so as the economy grows and as a nation we feed ourselves better. So the emphasis will have to be nurturing the farm base on a solid footing to have a stable economy. (IPA Service)