Is China’s offer to assist debt ridden European governments a gamble?

• As news broke this month suggesting it was more likely than ever that Greece was headed for default, China extended an offer of assistance that beleaguered European governments may find difficult to refuse. Premier Wen Jiabao announced that China was willing to increase its holding of European sovereign debt a time when several Eurozone countries are struggling to raise capital.
• In return, China seeks little–simply an assurance that profligate governments promise to get their financial affairs in order, and perhaps some other small favor that, in the words of Premier Wen Jiabao, “would reflect our friendship.” The Premier even suggested that a good way to demonstrate this new-found goodwill would be to support China’s bid to be reclassified as a “market economy” by the World Trade Organization.
• Currently, anti-dumping tariffs are applied against products shipped from China that are deemed to be sold at below the true market cost. This is an attempt to counter the subsidies and other incentives the Chinese government provides to many manufacturers to ensure their competitiveness; a change in designation would remove most of these tariffs.
• While lower costs may be good news for consumers, for European manufacturers, it could prove disastrous. Disadvantaging European manufacturers already facing weak domestic demand could lead to wider job losses and a further slowing of the economy. Eurozone officials would be well advised to consider carefully the potential impact on domestic manufacturers before agreeing to easing China’s access to the European markets.
• Either way, change will come within a few years, as China is slated to be re-designated as a market economy in 2016. Nevertheless, there is a very good reason why Beijing is trying to move the date forward – each year China comes under increased competition from other emerging economies.
• China’s ability to undercut other production centers has proven remarkably profitable, but outside events are forcing China to update its approach. By deliberately undervaluing its currency, China has created a massive trade surplus with its export markets which has resulted in the loss of manufacturing jobs in both the U.S. and Europe. These job losses have contributed to slower economic growth in Western economies, leading inevitably to an overall decline in consumer spending and, by extension, lower demand for China’s exports.
• At the same time as wealth has increased in China, so too has inflation and workers are demanding better wages to maintain current living standards. Workers now have more opportunities then they did in the past and employers are being forced to increase wages to attract and retain workers. Combine this with competition from smaller nations like VietNam where wages are lower, and it is understandable why China is concerned that its low-cost monopoly could be at risk.
• In mid-September, an official with China’s central bank said the bank intended to “liquidate more” of its U.S. assets  currently estimated at about $2.2 trillion in total. The timing of this announcement, coinciding with China’s offer to buy more European debt, is noteworthy; selling its U.S. holdings is the only way China could finance a large purchase of euros.
• However, this would not be without risk to China’s finances. Should China dump all, or even a large portion, of its U.S. securities on the markets, the value of the dollar would surely decline. For U.S. manufacturers, a weaker U.S. dollar would likely be beneficial as this would make American-made products more competitive both at home and abroad. It could be just what is needed to kick-start the economy. China, on the other hand, would suffer deep losses as the dollar declines.
• There is also the risk that despite China’s support, there could still be a Eurozone default. How far the euro may plunge following a default is anybody’s guess but the losses would be substantial. Ironically, the resulting uncertainty would lead to a heightened demand for the dollar as investors move to the safety of U.S.-denominated securities.
• Compared to the economies of Spain or even more likely Italy, Greece is so small, it barely registers. Yet over 200 billion euros have been committed to Greece in emergency funding so far with little to show in the way of progress. Using the experience with Greece as a guide, and understanding that Italy’s economy alone is more than six times that of Greece, the funding required to prevent an Italian default could easily reach into the trillions. The question for China is whether the potential increase in export sales is worth the risk.

IMF’s dire warning

• The International Monetary Fund has a creditable record of spotting, and tracking, world economic recovery more accurately than most other global institutions. As such its prognosis has always been keenly watched. Hence its warning, first issued while launching the latest edition of the World Economic Outlook on Tuesday and repeated on at least three different occasions, that the global economy was in “the danger zone” ought not to be treated as a hyperbole. The onus of taking corrective measures is squarely on politicians round the globe, and not just on those in the United States who have displayed an amazing disharmony in sorting out key economic issues.
• As Indian experience too demonstrates, a fiscal policy that is dictated by political considerations cannot complement the monetary policy adequately to achieve key objectives, such as reining in inflation. The global growth forecast for 2011 has been marked down to 4 per cent from 4.3 per cent. That small decrease in percentage terms, however, does not fully reflect the fears and forebodings of the IMF, which stand reinforced by its Global Financial Stability Report (GFSR), released almost simultaneously with the WEO. The report serves as an early warning system and recommends policy action to stave off a crisis.
• There are ample reasons for policymakers of both the developed and the developing countries to worry, as risks of financial instability have increased significantly in the past few months. The global financial crisis that began with the U.S. sub-prime loans and then morphed into a systemic banking problem with international implications is far from being resolved. The sovereign debt crisis in the euro zone countries represented the next stage. Now, there is a political phase where a consensus on fiscal consolidation and adjustment has been eluding the politicians on both sides of the Atlantic.
• As part of a three-pronged action plan for the developed countries, the IMF has called for a credible, medium-term fiscal adjustment plan. The U.S. should take steps to resolve the problem of overstretched household balance sheets through an aggressive restructuring programme. Thirdly, the banking sector in Europe should be fixed immediately, if necessary through infusion of capital. Developing countries need to avoid a further build-up of financial imbalances. In words that seem prophetic, the IMF has cautioned that countries such as India will face a sudden reversal of capital flows if foreign investors see their growth prospects petering out. In the post-crisis period, country risk assessments have become more important than interest differentials.

Europe’s high-risk gamble

• The Greek government needs to escape from an otherwise impossible situation. It has an unmanageable level of government debt (150% of GDP, rising this year by ten percentage points), a collapsing economy (with GDP down by more than 7% this year, pushing the unemployment rate up to 16%), a chronic balance-of-payments deficit (now at 8% of GDP), and insolvent banks that are rapidly losing deposits.
• The only way out is for Greece to default on its sovereign debt. When it does, it must write down the principal value of that debt by at least 50%. The current plan to reduce the present value of privately held bonds by 20% is just a first small step toward this outcome.
• If Greece leaves the euro after it defaults, it can devalue its new currency, thereby stimulating demand and shifting eventually to a trade surplus. Such a strategy of “default and devalue” has been standard fare for countries in other parts of the world when they were faced with unmanageably large government debt and a chronic current-account deficit. It hasn’t happened in Greece only because Greece is trapped in the single currency.
• The markets are fully aware that Greece, being insolvent, will eventually default. That’s why the interest rate on Greek three-year government debt recently soared past 100% and the yield on ten-year bonds is 22%, implying that a €100 principal payable in ten years is worth less than €14 today.
• Why, then, are political leaders in France and Germany trying so hard to prevent – or, more accurately, to postpone – the inevitable? There are two reasons.First, the banks and other financial institutions in Germany and France have large exposures to Greek government debt, both directly and through the credit that they have extended to Greek and other eurozone banks. Postponing a default gives the French and German financial institutions time to build up their capital, reduce their exposure to Greek banks by not renewing credit when loans come due, and sell Greek bonds to the European Central Bank.The second, and more important, reason for the Franco-German struggle to postpone a Greek default is the risk that a Greek default would induce sovereign defaults in other countries and runs on other banking systems, particularly in Spain and Italy. This risk was highlighted by the recent downgrade of Italy’s credit rating by Standard & Poor’s.
• A default by either of those large countries would have disastrous implications for the banks and other financial institutions in France and Germany. The European Financial Stability Fund is large enough to cover Greece’s financing needs but not large enough to finance Italy and Spain if they lose access to private markets. So European politicians hope that by showing that even Greece can avoid default, private markets will gain enough confidence in the viability of Italy and Spain to continue lending to their governments at reasonable rates and financing their banks.
• If Greece is allowed to default in the coming weeks, financial markets will indeed regard defaults by Spain and Italy as much more likely. That could cause their interest rates to spike upward and their national debts to rise rapidly, thus making them effectively insolvent. By postponing a Greek default for two years, Europe’s politicians hope to give Spain and Italy time to prove that they are financially viable.
• Two years could allow markets to see whether Spain’s banks can handle the decline of local real-estate prices, or whether mortgage defaults will lead to widespread bank failures, requiring the Spanish government to finance large deposit guarantees. The next two years would also disclose the financial conditions of Spain’s regional governments, which have incurred debts that are ultimately guaranteed by the central government.
• Likewise, two years could provide time for Italy to demonstrate whether it can achieve a balanced budget. The Berlusconi government recently passed a budget bill designed to raise tax revenue and to bring the economy to a balanced budget by 2013. That will be hard to achieve, because fiscal tightening will reduce Italian GDP, which is now barely growing, in turn shrinking tax revenue. So, in two years, we can expect a debate about whether budget balance has then been achieved on a cyclically adjusted basis. Those two years would also indicate whether Italian banks are in better shape than many now fear.
• If Spain and Italy do look sound enough at the end of two years, European political leaders can allow Greece to default without fear of dangerous contagion. Portugal might follow Greece in a sovereign default and in leaving the eurozone. But the larger countries would be able to fund themselves at reasonable interest rates, and the current eurozone system could continue.
• If, however, Spain or Italy does not persuade markets over the next two years that they are financially sound, interest rates for their governments and banks will rise sharply, and it will be clear that they are insolvent. At that point, they will default. They would also be at least temporarily unable to borrow and would be strongly tempted to leave the single currency.
• But there is a greater and more immediate danger: Even if Spain and Italy are fundamentally sound, there may not be two years to find out. The level of Greek interest rates shows that markets believe that Greece will default very soon. And even before that default occurs, interest rates on Spanish or Italian debt could rise sharply, putting these countries on a financially impossible path. The eurozone’s politicians may learn the hard way that trying to fool markets is a dangerous strategy.

new mechanism for funding infrastructure projects

• Mechanisms for funding infrastructure projects in India are gradually falling in place. Recently, three institutions — IIFCL, LIC and IDFC — entered into a memorandum of understanding (MoU) to provide ‘takeout’ finance for up to 50 per cent of the total project cost on which banks initially extend credit. There is no dearth of funds available with banks; the problem lies in their predominantly short-term deposit tenure, with a significant part maturing in less than a year. That creates asset liability mismatches (ALM) when they take exposure in infrastructure projects with long gestation periods. ‘Takeout’ financing enables banks to fund projects initially and then transfer the loans outstanding to the books of financial institutions (that have long-term money but not enough to meet the entire debt requirementsof these projects). The MoU signed by the three institutions is expected to facilitate financing to the tune of Rs 30,000 crore.
• The other major boost to infrastructure financing has come from the guidelines issued by the Reserve Bank of India (RBI) on the sponsoring of infrastructure debt funds (IDF) by banks and non-banking financial companies (NBFC). The RBI has allowed them to set up IDFs either as mutual funds or as NBFCs. The IDFs can potentially serve as vehicles to attract overseas money, especially from insurance and pension funds that can make long-term investments. IDFs will provide an additional route for banks to surmount the problem of ALMs, and avoid breaching their internal ceilings for direct lending to the infrastructure sector. The RBI norms for NBFC-sponsored IDFs stipulate minimum net owned funds of Rs 300 crore, a 15 per cent capital adequacy ratio, and a record of profitable operations for the last three years. Not many NBFCs will meet these stiff criteria. But given that infrastructure finance is an area where banks with better resources and risk management profiles prefer to tread cautiously, there is perhaps merit in raising the barhigher. That explains the RBI’s additional requirement that IDFs should invest only in public private partnership projects and those in commercial operation for at least a year. Thus, they (and the takeout financiers) will step in only after the banks lend, and bear the attendant risks, at the start-up stage.
• All these are good facilitative steps that will further the Government’s goal of investing one trillion dollars in infrastructure over the next five years. But recent experience shows that financing is not as much an issue in infrastructure as are the policy uncertainties relating to land acquisition, input linkages or tariff-setting. It is the lack of clarity on these fronts that is really hindering investments. The Government needs to attend to these and also put its fiscal house in order to free up more resources for power, roads, ports or irrigation.

rupee under pressure

• Amidst the turmoil in the stock markets, one might choose to underrate or even ignore the significance of the sudden volatility in India’s foreign exchange markets. That would be unfortunate. The rupee’s steep fall against the dollar, after a fairly long period of stability, is a development that has major implications not just for exporters and importers but for the macroeconomy. The sharp declines in both the stock markets and in the rupee’s external value, interrelated as they are, have some common features.

• With the global economy pushed to the brink by the persisting sovereign debt crisis in the euro zone countries, the uncertainty in the global financial markets increased as a natural consequence. Last week, there was a huge sell-off in the stock markets around the world, including India. At the global level, there is a strong demand for dollars as a safe haven. Ironically, all the troubles the United States is facing — a sharply lower-than-expected economic growth, persistently high unemployment, and fractious politics — have not dimmed the lustre of the American currency.

• Heightened risk-aversion, which is a direct consequence of the global crisis, has caused investors to liquidate their assets in what they perceive to be riskier markets and repatriate the money to safer destinations. Consequently, the demand for the dollar from exiting foreign institutional investors has risen in India, pushing up its price. In times of great uncertainty as now, it is not the prospect of better return but safety that drives investment decisions.

• On Monday, the rupee traded around Rs.49.60 to the dollar, perilously close to the psychologically important Rs.50 mark. In the current phase of rupee depreciation, the RBI does not appear to have intervened aggressively, possibly because it wants to conserve its firepower for a future contingency. The foreign currency reserves at around $318 billion may be comfortable, but not sufficient for a long-drawn campaign of intervention. Besides, the negative sentiment is driven entirely by global factors over which the RBI has no control.

• Also, the growing dependence on short-term flows and the widening current account deficit might neutralise the impact of intervention. As a rule, a depreciating rupee is good for exporters. But this time, the swing is so sudden and sharp that the exporters were, probably, caught off-guard. In any case, many of them would have hedged their positions. These explain why there has not been an adequate supply of dollars in the domestic market. But the truth is that exporters, like importers, prefer stability in exchange rates. The chances are that exchange rate management will be more challenging in the days to come.

Sensex bounced back by 305 points in opening trade on Tuesday

• The Bombay Stock Exchange benchmark Sensex rebounded by almost 305 points in opening trade Tuesday after a three-day losing streak on the emergence of buying by funds and retail investors, tracking a firming trend on other Asian bourses.
• The 30-share BSE index, which lost nearly 1,015 points in the previous three sessions, recovered by 304.92 points, or 1.89 per cent, to 16,356.02 in the first five minutes of trade Tuesday, with all the sectoral indices trading in positive terrain with gains of up to 2.56 per cent.
• Likewise, the wide-based National Stock Exchange Nifty Index also moved up by 91.30 points, or 1.88 per cent, to 4,926.70.
• Brokers said a fresh spell of buying by funds and retail investors in recently beaten-down stocks, driven by a firming trend on the other Asian bourses following overnight gains in the U.S. on hopes that European policymakers would find a solution to stabilise debt-stricken Greece, buoyed the trading sentiment.
• In addition, covering-up of short positions ahead of monthly expiry in the derivatives segment on Thursday also helped stocks to recover, they said.
• In the Asian region, Hong Kong’s Hang Seng Index rose by 2.44 per cent and Japan’s Nikkei Index by 1.80 per cent in morning trade Tuesday. The U.S. Dow Jones Industrial Average closed 2.53 per cent higher Monday.

obvious dangers of external borrowings in the context of indian economy

• The Indian corporate sector appears to have stepped up its borrowing from the international market. Monthly figures on private external commercial borrowing (ECB) released by the Reserve Bank of India point to a significant increase in in the volume of such borrowing. As compared with a total of $12.2 billion borrowed over the six months ending January 2011, external borrowing over the subsequent six months (ending July 2011) had touched $19.3 billion. Moreover, underlying month-to-month variations in the volume of borrowing because of the presence or absence of large individual borrowers, is a trend pointing to a continuous rise. As a result, while the current ceiling on ECB is $30 billion in a single financial year, Indian companies have already borrowed close to $16 billion over the first five months (April-August) of this financial year (2011-12).
• What is noteworthy is that the recent increase in borrowing has been accompanied by an increase in the trade and current account deficits on India’s balance of payments and signs of a weakening of the Indian rupee vis-à-vis the dollar. As argued below, both of these have implications for an assessment of the implications of the increase in external commercial borrowing.
• The obvious cause for the close to 60 per cent surge in ECB over the last two six month periods for which data is available is the sharp rise in domestic interest rates. The Reserve Bank of India has announced 12 increases in reference rates since March last year, raising the cost of credit provided to the banking system by 3.25 percentage points to 8.25 per cent. This being the rates at which banks can borrow from the RBI, they in turn are charging higher rates on loans to their clients. In the event, there has been a widening of interest rates payable on borrowing from the domestic and external markets, with the latter being the cheaper source. When the differentials in interest rates between external and domestic markets widen, the normal tendency would be for firms to borrow abroad to meet even their domestic expenditures and finance their expansion plans targeted at the domestic market.
• There are, however, two much-discussed dangers associated with this tendency. First, there arises a mismatch between the currency in which debt service commitments on external loans must be met and the currency in which revenues are garnered from the domestic market-oriented activities that are financed by such loans. Hence, a part of the foreign exchange earned or acquired in other activities would have to be diverted to these borrowers in the future so that they can meet their debt service commitments. This could put some strain on the balance of payments.
• The second problem is that the borrowers themselves are taking on substantial exchange rate risks. While they may be obtaining finance at interest rates lower than currently charged in the domestic market, their debt service commitments in rupee terms can rise sharply if there is a depreciation of the domestic currency. This could more than neutralise the benefit of an interest rate differential.
• Besides these factors, another possibility is a rise in in rates in international markets. Those interest rates are low now because central banks in the developed countries have pumped large volumes of cheap liquidity into the market in response to the crisis. But there is no guarantee that the era of access to cheap liquidity for emerging markets will continue, as illustrated by the difficulties being faced by the peripheral countries in the Eurozone. If rates rise, efforts to refinance maturing debt would require expensive borrowing. Put all of this together, and the rise in external borrowing increases the vulnerability of the corporate sector and the nation.
• It is for these reasons that the widening of the current account deficit on India’s balance of payments and the weakening of the rupee against the dollar at a time when external commercial borrowing is rising give cause for concern. Faced with such a situation the government should seek to limit external borrowing to instances where access to foreign exchange is socially important, as for example when capital goods have to be imported for crucial infrastructural projects.
• However, the government appears to be inclined towards loosening rules with respect to external borrowing, to dampen corporate criticism of the high interest rate regime. Under pressure from the corporate sector, the government had increased in May the ceiling it sets on total external commercial borrowing in a single financial year by $10 billion to $30 billion. More recently, the government has increased the cap on borrowing by individual firms in the microfinance, services and infrastructure (and other) sectors (for loans with maturity of more than 5 years under the automatic route) from $5 million, $100 million and $500 million respectively to $10 million, $200 million and $750 million. Moreover, the government has been permitting the use of ECBs for refinancing rupee loans. Telecom companies who borrowed in rupees at high cost to finance spectrum acquisition have exploited this facility substantially.
• Thus, while retail borrowers are experiencing sharp increases in the equated monthly instalments or the tenure of the loans they took on to finance housing investments or purchases of automobile and durables, corporates are being offered an escape to cheap credit through means that increase external vulnerability. This quirky policy is clearly aimed at neutralising the impact of interest rate hikes in the domestic market on the corporate sector, so as to dampen criticism of the government’s mismanagement of inflation control and the failure of its policy of relying solely on interest rate increases to rein in prices.
• There are conspiracy theories doing the rounds. Rumour has it that there is a standoff between the Ministry of Finance and the Reserve Bank of India over interest rate policy. The government seems completely at a loss to find ways of reining in inflation. Rather it is worsening the inflation problem through periodic hikes in administered prices, especially that of petroleum. This has forced the central bank to take on the burden of combatting inflation leading to the sharp rise in interest rates. But the Finance Ministry does not seem to like that either, and is using the ECB lever to counter the impact of the RBI’s intervention on the powerful corporate sector. But that could increase external vulnerability, which could be the next source of conflict between these two agencies.

the shadow of recession

• Bad news about the euro area now streams from all directions. European finance ministers flunked hard decisions on combating the debt crisis at a meeting in the Polish city of Wroclaw on September 16th and 17th and instead floated the irrelevant idea of a tax on financial transactions. Italy’s credit rating was downgraded this week by Standard & Poor’s (S&P).
• In Athens, the Greek government and the troika of international institutions overseeing its austerity programme have been sparring over what else Greece needs to do to get its next, €8 billion ($11 billion) tranche of bail-out funds. Evangelos Venizelos, the Greek finance minister, complained that Greece was being “blackmailed and humiliated”, although it has little choice but to knuckle down: on September 21st, it announced measures to raise taxes, speed up public-sector lay-offs and cut some pensions. A decision on the money is expected in October.
• Another current of gloom, slower-moving than the debt crisis but just as ominous, is also in full flow. The outlook for the euro-area economy is deteriorating fast, which augurs ill for attempts to wrest the finances of indebted countries under control. At best there will be a wrenching slowdown; at worst, a relapse into recession.
• At the start of this year a surging recovery, led by Germany, was one reason to think that the euro zone could withstand the debt crisis. The second quarter was a disappointment, however, with GDP growth slowing from 0.8% to 0.2% in the euro area and from 1.3% to 0.1% in Germany.
• New official forecasts make clear that the spring slowdown was no blip. On September 20th the IMF yanked down its predictions for euro-area growth this year and next to 1.6% and 1.1% (see chart). A few days earlier, the European Commission envisaged growth slowing to a virtual standstill, with euro-area GDP rising by 0.2% in the third quarter and just 0.1% in the fourth.
• The prospects for southern Europe are dispiriting going on depressing. Unsurprisingly they are worst for Greece, whose economy is now expected to contract for four successive years. After shrinking by 2% in 2009 and 4.4% in 2010, its GDP will get 5% smaller this year and 2% smaller in 2012, according to the new IMF forecasts. In July the fund had predicted a return to modest growth in 2012.
• Portugal also faces a dismal year: the fund forecasts a fall in GDP of 1.8% in 2012 after a 2.2% decline in 2011. And although Italy’s economy will at least manage to grow, it won’t feel like it. The IMF thinks that Italian GDP will rise by just 0.3% in 2012, down a full percentage point from the 1.3% it predicted in June.
• The pain may be most intense in southern Europe, where the pressure for austerity is greatest, but the core economies will also be hurt. German growth will slow from 2.7% this year to 1.3% in 2012, according to the IMF. The short-term outlook could be even worse. The latest ZEW survey of analysts’ expectations for the German economy in six months’ time suggests that it is heading towards a downturn. Holger Schmieding, an economist at Berenberg Bank, thinks that a loss of confidence will push the German economy into a mild recession in late 2011 and early 2012.
• A vicious feedback loop between growth, sovereign-debt concerns and banking woes is now in train. S&P cited weakening growth prospects as a crucial reason why it lowered its credit rating for Italy: a more sluggish economy will make it harder for the government to achieve its fiscal targets. The rising risk of recession will damage a fragile European banking sector, which already faces potential losses of around €200 billion from higher risk on sovereign debt, according to new IMF estimates. And if the German economy falters, that is likely to make it even trickier for Angela Merkel to convince German taxpayers that they must dip deeper into their pockets to rescue the euro. Dealing with the debt crisis just seems to get harder and harder.

unaddressed issues of inflation in India

• For more than two and half years, food price inflation has been uncomfortable and intolerable with high levels of 8% and more. And the same is true for overall inflation for year and half. Though the demand supply imbalances are corrected frequently, inflation could not be contained because, focus of inflation has shifted across commodity group.
• During April-july 2010, wholesale price index(WPI) increased 3.4%,where 32% was accounted for by manufactured non-food products,30% by food articles and 24% by fuel and power. Subsequently,during Aug-Nov 2010, WPI increased by 25%, was largely due to primary non-food articles and minerals(38%),with food articles by 28%,manufactured non-food products accounted for 28%.Fuel and power were not the important drivers of inflaton during this period. Finally, during Dec.2010 to July 2011, WPI was increased by 7.1%,where manufactured non-food products accounted for 43%, fuel and power accounted by 25% and food articles by 23%.
• Continuous shift in the focus of inflation suggest that multiple factors like imported inflation,administered price increase, speculation,supply-demand imbalance, made inflation keep high. The above factors that effect the inflation are the outcome of economic reforms like links between Neo-liberalisation and inflation. India’s vulnerability to the effects of changes in international prices has increased  with trade liberalization, dilution of anti-trust measures and reduced regulation trend to encourage a profit driven sector will raise prices of that particular sector goods like pharmaceuticals.
• Imbalance between demand and supply of primary products are increased by government’s reluctance to release additional food through PDS (public distribution system) in order to curb subsidies.The effort to reduce subsidies has also resulted in a continuous increase in the price of commodities such as petroleum and fertilizers , whole sale prices are administered.
• With income levels raising rapidly, demand for number of commodities increase,but supply may or may not match the demand, might lead to rise of prices in commodities, is a result of this fractional imbalance. For the governments that are committed to libaralisatin and deregulation, combating inflation is a herculion task.
• RBI(Reserve Bank of  India) is the only organization in India that addressed inflation , has largely relied on single instrument i.e, Monetary policy, related to changes in rates that effects the financial system. RBI increases interest rates to moderate investment demand, contain debt-financed housing purchases and consumption, dilute speculation financed with credit. RBI in recent past has increased rates,much more than the market expected. The repo rate has been increased by 3% points from 5% to 8% over the last 16 months.Clearly , RBI heavy reliance on this instrument has not helped matters. It has attributed inflation to factors than can be addressed only in the medium or long term, but do not have any  solution to immediate inflationary surge or a short term solution.
• According to RBI, inflation reduction needs “improved supply response for food, higher storage capacity for grains, cold storage chains to maintain supply side shocks in persishable produce and market based incentives to augment supply of non-cereal food items”. This complemented with “ better management of water as also technical nad institutional improvement in the farm sector and allied activities. Land consolidation, harvesting technologies and supply chain to retail points , all can contribute to lowering inflation and the inflationary expectations that are formed adaptively”. There is a need for environmentally sustainable solutions to manage energy security, stamp out anti-competition practices and collusive behavior that contribute to inflation.
• RBI’s focus on long-run supply side constaints serve three purposes. The first is that it absolves the government and the RBI of the responsibility of addressing the persisting inflation problems immediately.If growth increases demand, then ew need to adjust supply to hold prices, which is a long term process. Secondly, the growth that occurs bypasses sectors such as agriculture and in the process exacerbates rather tha resolves supply side problem. Urban development and disproportionality that contribute to inflation are a part of neo-liberal growth. Thirdly,the argument seeks to direct attention from the link between the cement inflation and neoliberal economic policies. Rather, the supply side argument allows the RBI to advocate further neoliberal reform to remove distorting subsidies (recommended with respect to fertilizers) and strength the supply chain (through encouraging large retail). It also argues for free pricing of petroleum products, since “ a large population cannot be subsidized in an import dependent item”. In its view, neoliberal economic policies are not a cause of inflation , but a solution.
• RBI has no immediate solution to the inflation problem at hand, only emphasizing on interest rates. It focuses on supply-side policies, which can achive little in the short run.

It is not impossible for politicians to reduce the West’s frighteningly high unemployment levels

• A little  geographical imagination helps to convey the scale of joblessness in the West. If the 44m people who are unemployed in the mainly rich members of the OECD lived in one country, its population would be similar to Spain’s. In Spain itself, which has the West’s highest jobless rate (21%), the number of people without work matches the combined population of Madrid and Barcelona. In America the 14m people officially jobless would form the fifth-most-populous state in the union. Add in the 11m “underemployed”, who are working less than they would like, and it is the size of Texas.
• The landscape is not uniformly bleak. Germany, for example, now has a lower jobless rate than before the financial crisis. But in most of the rich world the proportion of people unemployed, though down a bit from its peak in 2009, is still alarmingly high, even as fears mount that several countries may be slipping back into recession. And the human cost of the economic crisis is paid largely by those who are out of work, for joblessness increases depression, divorce, substance abuse and pretty much everything that can go wrong in a life.
• Worse, today’s joblessness is a particularly dangerous sort. A disproportionate share of those out of work are young, and youth unemployment leaves more scars, in terms of lower future wages and greater likelihood of future unemployment . Joblessness is also becoming more chronic. In America, famous for its flexible labour market, the average jobless spell now lasts 40 weeks, up from 17 in 2007. In Italy half of those without work have been so for more than a year. Long-term unemployment is harder to cure, as people’s skills atrophy and they become detached from the workforce. Its shadow lingers, reducing future growth rates, damaging public finances and straining social order for years to come.
• This mess will not be fixed quickly. Even if growth accelerates, unemployment will remain worryingly high for several years. Many remedies, such as retraining workers, take time. But that only makes it all the more shocking that politicians have done so little. America is stuck in a sterile debate, with the left claiming that the government is not spending enough, while the right insists that big government is destroying jobs. An increasingly unpopular Barack Obama was due to address Congress on the subject just after The Economist went to press. Across the Atlantic many of the responses to the euro crisis seem designed to drive up joblessness. The West’s leaders can and must do better.
• The immediate priority should be supporting demand—or at least not doing harm to it. The left is right on one thing: the main cause of the current high joblessness is the severity of the last recession and the weakness of the subsequent recovery. Yet the West’s economies have embarked on contractionary policies. In some cases the fault lies with monetary policy: the European Central Bank should reverse its recent rate rises. But the main culprit is a collective, premature shift to fiscal austerity by governments.
• As this newspaper has repeatedly argued, politicians need to strike a bargain with the bond markets: combine policies that cushion growth now with measures that will bring deficits under control in the medium term. Raise the retirement age, for instance, and that leaves more room to stimulate growth in the short term. A minimal test of Mr Obama’s jobs agenda will be whether it is big enough to counter the fiscal tightening, equivalent to 2% of GDP, that is slated for next year.
• Where should the short-term money go? Some forms of stimulus are better than others at supporting employment. Germany’s subsidies for shortened working hours helped dissuade firms from firing workers; Mr Obama’s subsidies for green technology fattened the bottom line of a few chosen firms but did very little to spur jobs. Governments should prioritise policies that do. Some infrastructure spending, such as building roads and repairing schools, falls into that category. So do tax incentives that cut the cost of hiring, particularly for extra new workers—which is why it makes sense for America to extend, and even expand, its payroll-tax cut. And so, in America’s case, does federal aid to the states, since the main way states cut their budgets is by firing worker.
• So there are ways in which government money can help. But it is also plain that the jobs mess is not just about demand: it cannot be solved with more stimulus alone. There is plenty of evidence—from declining employment rates for less-skilled men to rising disability rolls—to suggest that Western economies had a brewing jobs problem long before the financial crisis hit. The combination of new technology and globalisation has reduced the demand for the less skilled, and many workers, particularly men, have failed to respond to these deep changes in the labour market. The shift in demand for skills has a long way to go, as our special report on the future of work explains. It suggests an important part of any jobs agenda must involve changes in education, more training to equip people in the rich world for tomorrow’s jobs and getting government off entrepreneurs’ backs.
• But it is also clear that labour-market policies themselves can make a huge difference. In many cases this means deregulation. In Spain 46% of young people under the age of 25 are out of work because there is a two-tier system, with mollycoddled “permanent” workers and easy-to-fire “temporary” workers, who are disproportionately young. Europe’s Mediterranean economies could learn a lot from Germany’s labour-market overhaul. America is better at creative destruction, but it invests too little in ways to help the unemployed back to work. Mr Obama could usefully look to the Netherlands and Denmark for ideas on how to overhaul an antiquated unemployment system and improve its training schemes.
• Do all these things correctly and the quest for jobs will take less time. But it has taken Western governments too long to grasp the seriousness of their jobs problem. Many people will suffer because of that.