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Monetary policy might reduce inflation, but it would cause disaster
History, it seems, is getting repeated again in India. Way back in 1994 when India was tasting the success of economic reforms, the government (with elections in mind) panicked at the sight of inflation. The hike in bank rates, then was taken up to control inflation. It took India almost 5 years to walk out of the industrial recession that followed.
Welcome now to the year 2007. Indian economy with a GDP of around $850 billion is booming at a rate of over 8%. Inflation is again lurking dangerously and the rulers are the same as in 1994. In comes the monetary policy that hikes interest rates. The goal remains the same as in 1994 and that is to reduce politically dangerous inflation (as elections are near in many states). The result is what we have to wait for. Summarily, the entire output of the economy is certainly going to affect everybody in a nutshell. In the past 2 years, since 2004, the inflation rate has increased from 3% to over 6%, raising the prices of almost everything. The reason given for this has been the increase in input cost in most of the manufacturing products.
While cutting down the existing heavy import duty on cement, steel and edible oil could have been feasible alternatives for the government, it has chosen a path that might hurt the economy in the long run for which they seem to care the least. The increased rates have shot up the returns on the fixed deposits for the politically sensitive middle class (the banks were quick to announce the higher returns), but for those that have availed loans on ‘floating rates’, sufferings might just have begun. Manmohan Singh isn’t a fool to not understand this, but he definitely has ‘political’ compulsions.
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