The BRIC nations are reeling under high inflation, much of it due to growing domestic demand. But a substantial part can also be attributed to high global commodity prices, especially crude.

Expansionary policies in the wealthy nations are also, to a very small extent, contributory factors. The headline inflation in India has again started to creep up, reaching 9.44 per cent on June 2011 from 8.82 per cent in August 2010 when the new WPI index was introduced.

A moderation in growth is expected and the regulator has maintained a base-line growth of 8 per cent, lower than the governments' projection of 8.6 per cent.

There also seems to be a tighter liquidity condition prevailing with average LAF volumes of Rs 52,000 crore for the week ended July 23 compared with Rs 34,600 crore for the week ended April 29.

It is inevitable that the economy will see a moderation in growth and many of the supply side constraints need to be addressed before a higher than 8 per cent growth rate is achieved without overheating.

However, improving agricultural productivity and supply infrastructure is a long-term measure and we will have to be content with a sub 8.5 per cent rate, if inflation has to be kept moderate.

Fiscal policy

The central bank's anti-inflationary stance needs to be supported by the central government with a tightening of the fiscal policy; else the effect of increasing interest rates will be negated.

As the policy statement points out, the government fiscal deficit turned out to be higher in April-May 2011 than that for the corresponding period the previous year. A rising interest rate scenario hits the banks both in terms of top-line and bottom-line.

While on one hand the credit offtake slows down on the other hand the quality of existing assets deteriorate as it becomes increasingly difficult for some assets to be serviced, requiring banks to provision more or move the boundary assets towards NPA classification.

It is most likely that the banks will pass on the whole burden to the customers, given that the sustained period of rate hikes would have eroded any cushion they may have had.

Going forward a better than expected monsoon will ease food inflation, but non-food inflation will remain tough to manage and will keep the overall inflation levels high.

Interest rate-sensitive sectors such as banks, real estate, automobile, consumer durables and corporate investments in expansion will be impacted adversely. It is likely that the central bank will take a breather for the next quarter.

(The author is National Leader, Global Financial Services, Ernst & Young. >blfeedback@thehindu.co.in )

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