beyondbrics

Why is the scandal-hit Indian government seemingly doing so little about inflation? Because it’s so busy worrying about elections.

That’s the view of many commentators, among them blogger R Jagannathan, on Firstpost.com, who has even coined a phrase to describe India’s persistently high level of price increases. Rahul-flation, he calls it, after Rahul Gandhi, the scion to India’s Gandhi family political dynasty. It could catch on.

Jagannathan argues that the Congress party that dominates the coalition government is probably aiming to put Rahul Gandhi forward as its candidate for prime minister in the next federal elections, which must be held by 2014.

He writes:

Why is inflation refusing to lie down and play dead when the Reserve Bank has trained all its guns on it? Why is a government headed by an economist, and who is further surrounded by even more first-rate economists (Kaushik Basu, C Rangarajan, and Montek Singh Ahluwalia), not able to do anything more than wring its hands in despair about inflation?

The answer, in one line, is simple. India’s inflation is driven by populist spending and wrong economic choices – both dictated by the need to create an entitlement-based economy, presumably to help elect Rahul Gandhi as the next prime minister in 2014.

In short, what we are seeing now is Rahul-flation, not conventional inflation.

This leaves the entire burden of fighting inflation resting on the central bank. Even as other major emerging markets slash rates (including Brazil last week) , India’s central bank on Tuesday raised interest rates for the 13th time since March 2010 in its fight against inflation.

With the government distracted by scandals and electioneering, the central bank can’t rely on New Delhi to cut public spending and borrowing.

Monetary policy, economists told beyondbrics, is simply the only tool India has to fight persistently high inflation – which reached 9.72 per cent in September, down from 9.78 per cent in August – while fiscal policy paralysis and keep the Congress Party-led coalition government’s reform agenda stagnant.

A Prasanna, of ICICI Securities, called cutting the fiscal deficit a “no-brainer” – and urged an easing of regulation and a clarification of convoluted policy across sectors, from agriculture and industry to real estate.

As Rashesh Shah, chairman of Edelweiss, told beyondbrics earlier this month, bankers and economists are baffled as to why the government is not enacting meaningful fiscal reform: “I think currently that is what we’re trying to figure out,” Shah said. “I have no answer for why not – it seems like the most obvious thing to do to get the economy back on track.”

In the absence of government action, the central bank is responding with monetary policy to a host of challenges: the eurozone crisis driving demand for US dollars, a steadily weakening rupee (which hit the Rs50 mark against the dollar last week before slipping back and trading on Thursday at Rs49.3). a mushrooming fiscal deficit, supply side constraints, market volatility and a drop in foreign financial inflows.

India’s trade deficit continues to climb, despite the weakening currency. The deficit for April-July 2011 was around $42.7bn, up 12 per cent from $37.5bn for the same period last year, according to the Ministry of Commerce and Industry.

Meanwhile, global investments into India were at a net outflow of $206.6m from the beginning of the year until Thursday, down from $24.5bn in inflows during the same period last year, according to the Securities and Exchange Board of India, further hurting the rupee.

The RBI downgraded India’s growth forecast for the fiscal year ending March 2012, from 8 per cent down to 7.6 per cent – most economists see it as somewhere between 7 per cent and 7.5 per cent, well below the government’s original 9 per cent forecasts.

Yet even in the face of mounting economic problems, New Delhi remains mostly silent. It faces a daily barrage of negative news about corruption scandals – and the anti-corruption backlash that the scandals have spawned. Then there are regional elections in India’s most populous state, Uttar Pradesh. And after that the national elections of 2014. And Rahul. No wonder the central bank feels isolated.