After the Reserve Bank of India administered for the third time in a month the same old medicine of credit squeeze against the backdrop of high inflation, the Economic Times commented that the central bank knows that it must get on top of inflation but "it may not know quite what to do". The RBI is seen as a doctor who finds the fever of his patient going up relentlessly - inflation continued for the third week at a high of nearly 6.5 per cent - but knows only the administering of the same medicine that has not worked so far. So it does what most doctors would do-give a stronger dose of the same therapy. That is what the RBI has done, once again raising the cash reserve ratio and hiking the interest rate at which it lends to banks from the cash reserves.

Experts say that the RBI, like the Ministry of Finance, has begun to panic. The reason is political: The Congress has lost Assembly elections in two States - Punjab and Uttarakhand. Its fate in Uttar Pradesh is expected to be no more than that of a sidekick in the largest State's political scene - that is, despite the hoopla in the media over the political launch of Mr Rahul Gandhi. The blame game this will generate could scorch some people in the top echelons of the Union Government. One target could be Finance Minister P Chidambaram.

For all the assurances in Mr Chidambaram's Budget speech about containing inflation and the cheers over nine per cent growth, the reality is now unveiling itself. By resorting to credit squeeze successively over the last three months, the RBI hopes to reduce the growth rate in bank credit from 30 to 20 per cent. Econometricians believe that with a 20 per cent growth rate in bank credit, the inflation rate would be between five and 5.5 per cent. That is a bearable burden, both politically and economically. Hence the viciousness of the squeeze this time.

However, throughout the markets there is no confidence that the RBI's multi-drug therapy will work. The major reason is that the Government is not prepared to take the fundamental policy decision needed to bring inflation under control. That makes the RBI's medicine simply a symptoms-control measure, not an attack on the causes of the "overheating of the economy".

The basic cause is mismanagement of the economy. The political drive to create artificial employment across vulnerable districts has pumped large amounts of money into the system. There is increasing evidence of this money not creating any worthwhile assets. The Government has been unable to launch any major infrastructure project. For instance, the power sector continues to be in the doldrums due to the non-implementation of the Electricity Act of 2003 under political pressure. The leakage in the power sector continues to be as high as between 35 and 50 per cent. The road projects have got into a crawl. The proposed mega power stations are yet to get off the ground.

The Government is shifting the goalposts of industrial complexes like SEZs and mega retail stores that could build a supply chain between them and the farms. Farmers continue to commit suicide are continuing three years after the UPA Government came to power with the promise of addressing their plight. Apparently, due to bad governance the much-touted tripling of Government-funded credit to farmers is making no dent on their indebtedness. The politics of quota initiated by the Minister of Human Resource Development has led the Government into a Catch-22 situation. The regime lacks the political will to push ahead with economic reforms.

No wonder the RBI is left to tinker with monetary and credit policies in a bid to rein in inflation. The huge foreign exchange reserve and the rising inflow of remittances from abroad have placed the RBI in a dilemma. The natural result of these developments should be the strengthening of the rupee and its appreciation vis-a-vis the dollar. But the RBI is not allowed to do this because policy-makers have decreed that Indian exports should not lose their price competitiveness. So, the RBI has to keep buying dollars in order to keep the rupee depreciated. That leads to more rupee funds entering the market. To counter it, the RBI has to resort to squeezing the banks to park more and more of their funds with itself and lend less and less.

What the high interest rates will achieve, instead of controlling inflation, is to raise it even further in the long term. Rising interest rates will lead to larger inflow of foreign funds, multiplying RBI's worries to keep the rupee value steady. If the rupee is stabilised to help exporters remain competitive, it would have a completely different result as local interest rates would push up the cost of capital and, therefore, of production.

Meanwhile, the worst hit will be the aam aadmi, the UPA's favourite icon. Car loans and house loans will become more expensive. So, people will borrow less for buying a house or a car. The era of easy personal loans for the suffering middle class is destined to end. Hire-purchase of household appliances will become costlier.

The job market will be the worst hit. Higher cost of capital will force investors to re-work their investment plans. If investment were to go down, employment and spending power would also go down. The impending deceleration will hit the job market in a widening spiral, and the nine per cent growth showcased by the Government will end up as a pipe dream. Other basic steps needed to keep investments up and costs down have already been stalled. The combined force of socialists within the Congress and the Left over the survival of the UPA Government have ensured a freeze on basic reforms.

With adverse election results for the ruling party, the three-year long game is likely to turn into a farce. So don't be surprised if inflation continues with its northward journey and the RBI becomes more and more desperate. After all, the Government is gambling on hope, afraid to strike where it should.

Courtesy: www.dialypioneer.com, April 7, 2007