Policy resolution

Nothing will have dominated conversation as we head into the new year as much as food prices. Food price inflation during the third week of December 2009 hovered close to the 20 per cent mark,according to figures released on December 31. There is little question that it is beginning to pinch. And,as Finance Minister Pranab Mukherjee pointed out,third-quarter figures for farm production while not as terrible as once feared are unlikely to bring any degree of relief. But,as he went on to explain,there is little evidence that inflation is being pushed up by excess money supply. In other words,food is more expensive because of problems with its supply. And,as is explained elsewhere on these pages today,the root causes of those problems will only clear up when proper investment in farm productivity is incentivised.

But,the short- and medium-term issue is food inflation. And a fear has begun to gain ground that expectations of future inflation will begin to be a problem. In other words,individuals will begin to expect higher prices in the future; they will alter their behaviour and renegotiate contracts; and,thus,that higher expected inflation will feed back into actual inflation. The argument might appear persuasive,except that it doesnt appear to be supported by sufficient evidence. Are expectations indeed changing? Is that being reflected in new contracts? There is little to say that it is,and the anecdotal evidence runs the other way.

And,in any case,that is not an argument for tightening interest rates. These columns have consistently argued that interest rates are too blunt an instrument for reining in inflation of the sort that we see or even of any sort that we can currently reasonably project. Yet continued uncertainty about the monetary policy stance has its own costs. The RBI must,in the new year,inject some solidity and certainty into the debate. There are many less drastic instruments at its disposal such as,for example,the credit reserve ratio or CRR if it feels action is unavoidable. It should look at those first. But its priority must remain to flush the system of harmful uncertainty and to do nothing that would harm recovery,and growth.