He adds that the taming of inflation will also mean that being patient with the causes of inflation and there any fundamental discord between having high growth and price stability.

Excerpts from the exclusive interview with Indranil Sengupta:
 
The toll of the survey from the headlines we have so far seem to indicate that inflation will be a fundamental concern of the Budget. But there are several statements to indicate that growth will not be compromised and that the fight against inflation will be calibrated. Any thoughts on this?

 This is on the expected lines; the growth story is something paramount for policy to maintain and my sense is that if you look at all the leading indicators in the economy they all seem robust, so I do not think that growth is a concern at this stage. Inflation is a concern because a lot of inflation is been driven by supply shortage as the survey itself points out.

So I think that taming of inflation will also mean that we have to be patient with the causes of inflation because as the survey points out these are not things, which will go away in a hurry. At the same time it is important to understand that this is not demand driven inflation, so tightening monetary policy beyond a level will hurt growth and I think the government and the RBI will have to strike a fine balance there because for e.g. if inflation persists at 6 per cent levels for sometime inflation expectations could get revised.

So on one hand the RBI will have to address inflation expectations while the government will have to take more supply side measures to affect the supply side causes of inflation. I think that's where the partitioning of fiscal and monetary policy will have to be - in combating inflation.     

The survey seems to be little gung-ho on the external front. It expects the external imbalance to soften as the oil prices come down and says that the time is right for a more liberal trade policy and for a more fuller float of the rupee. Your comments on these observations.

 Two of the most important sources of imbalances are oil price and the possibility of further Fed tightening seen behind us, so that's positive from India's own perspective.

I do agree that this is a good time to look at capital account convertibility and I do expect the Budget to implement the first phase of recommendations that the Tarapore Committee had on Fuller Capital Account convertibility; given that flows are strong, the currency is strong at this stage, this is a good time to integrate world monetary system.

At the same time this also might be a good opportunity to let more FIIs into debt instruments because that also means that you will be able to develop the corporate debt market, which is in the holy grail of Indian policy makers for sometime.  

How are you all reading the global scene in Kotak? Do you expect that the pressure on inflation will continue to remain, given the global scenario and the global shortage of several food staples?

We are looking at inflation remaining firm in the immediate term but at the same time we see inflation turning somewhere by May and then stabilising within the 5 per cent range next year assuming that monsoons are normal and the oil seed crop is good.

The key factor is that there are two key sources of inflation, which are difficult to track at this point. One is the domestic crop like oil seeds has been bad, so there isn't anything to do except wait till this works itself out except perhaps cutting import duties on palm oil which we expect the Budget to do.

The other source of inflation is metal prices that's again imported inflation and here the government is at a further disadvantage because its already cut import duties almost down to 5 per cent, so there is very little that you can do on that front as well. There has been an increase in prices of machinery, tools and so on but then one has to wait and see whether this is a base effect reacting to the fact that inflation in these segments was just 2 per cent last year, so that's something one has to wait and see.

We think that the causes of inflation as of now are not systemic and so we expect that once these specific areas get addressed you will see inflation in India coming down to much more reasonable levels and plus you will have the base effect of high inflation of this period going forward next year, so I do not think that inflation would be a systemic worry for the economy going forward into the next year.                

The FM seems to prioritise high growth maintenance. How can high growth be sustained with moderate inflation, so the priority in sharp contrast to how the RBI puts it where price stability was an end in itself when the Governor last spoke? Here the priority seems to be high growth sustainability along with moderate inflation, so do you think he will not kill the goose that lays the golden eggs and that there won't be too much tax tinkering or tax increases this time around?

The government typically has growth as its prime objective and the Central Bank typically has inflation management price stability as its primary objective. At the same time I do think that the RBI does have a twin objective of high growth as well as price stability and I do not think the RBI is also going to compromise growth to maintain price stability.

I do not think that there any fundamental discord between having high growth and price stability. This is something that happens in advance countries because we are already at full employment and therefore if you grow beyond the demand for further labour, demand for in foods pushes up inflation.

Economic Survey 2006-07: Complete Coverage