Persisting high inflation will weaken investment 038; growth

Acceptance of a higher rate of inflation as the new normal an inevitable consequence of rapid growth will raise risks of accelerating inflation. In turn,this is likely to weaken incentives for investment,which will threaten the sustainability of growth. This is a vicious circle of high inflation,low investment and slowing growth, Gokarn said.

The RBI has raised interest rates eight times since March 2010,yer headline inflation hovered at 8.31 per cent in February.

The alternative is the kind of virtuous circle that the economy has already experienced during the five years preceding the crisis period. This was characterised by low inflation,high investment and fiscal consolidation,particularly on the revenue account,accompanying high growth as well as resilience during the crisis period. That is the configuration that we need to re-create to sustain growth, Gokarn said while addressing the Ficcis National Executive Committee meeting.

Gokarn said the country appears to be in a situation in which capacity constraints are helping convert supply-side pressures into generalised inflation. If,in fact,the contribution of investment spending to growth is declining,the constraints can only become more binding,further aggravating inflationary pressures if the growth momentum is kept going by other components of demand.

The current rate of inflation does raise concerns about the risks of spiralling,as high inflation becomes increasingly entrenched into the wage and price setting behaviour of workers and producers. In turn,if this were to adversely impact investment activity,the growth momentum would inevitably slow down.

I want to emphasise that it is not a tradeoff between growth and inflation. It is tradeoff between growth now and inflation in future.

According to Gokarn,for much of the past several months,the dominant contributors to it have been pulses,milk,eggs,fish and meat and fruits. Cereals have made virtually no contribution,while vegetables,with the exception of the onion spike in late 2010,were not very significant contributors.

To reiterate a point we have been making in both our policy statements and other communications: this pattern is the outcome of consumption baskets being diversified by an increasing number of households as they cross some income threshold, he said.

The increase in prices indicates that supply is just not keeping pace with demand,he said.

The only way to keep food prices in check is to produce more of what people want to consume. There are several initiatives in the Union Budget for 2011-12,which are based on this recognition. Now,the emphasis must be on implementing the schemes for quick increases in productivity and output of the items in question, Gokarn said.

He said food inflation may have grabbed the headlines in recent months,but the fact is that it has been steadily increasing its contribution to overall inflation for some time now.