Lets take this case for our study. Currently( in year 2009), India faced deficient monsoon rains. India is an agrarian economy with 50-70% of the population depending on farming or agriculture-related work. Agriculture and agriculture related work contribute to about 18% of India's GDP. Most Indian farmers live below the poverty line (earning less than $2 a day). Majority of the Indian farmers largely rely on monsoon rains for farming since there are no adequate irrigation facilities. Only very few states of India have sufficient irrigation facilities. So, with the monsoon rains failing this year (well below the normal level - around 40% less than the normal in certain states and around 26% less than normal in many other states), India has declared many districts as drought-hit districts. It is expected that this failure in monsoons will bring food-scarcity in India (India has a population of around 1.1 billion). Thus the demand for food products is about to go up, which would drive up the food prices, thereby causing inflation. The Indian Govt says that there is adequate food storage available but it has to be wait and seen to know if the storage will be really sufficient.
A special point to note here is the commodity "Sugar". India is the largest consumer of sugar in the world (remember Indian sweets :) ) and I think is the largest producer and exporter of sugar too (not sure though). But this year, with the sugarcane crops failing due to poor monsoon rains, the supply of sugar is going to go down, and hence the price of the sugar is going to shoot up (because the Indian Govt will be buying sugar in the international markets to meets its domestic demand and will hence bid up the prices due to a tight supply in sugar in international markets while the demand remains strong).
Ok, so coming to our case-study, the Reserve Bank of India(RBI) (India's Central bank) has warned the Govt of short-term(due to increase in prices of food products) to mid-term inflation(due to increase in food prices + reduced interest rates and other monetary easing) and has therefore recommended to the the Govt (basically hinted) that it would like to cut back the monetary easing and bring up the interest rates (the interest rates were brought down as a response to the global financial crisis, to increase credit flow and demand) soon before its too late.
So, what do you think about the RBI's recommendation. When I can understand that recommendation to cut back the monetary-easing stance is to reduce inflation, will this not slow down growth in the one of the fastest growing economies of the world? Will this not be counter-productive to the very poor farmers that the Govt is actually trying to help? Will this recommendation, if implemented, not be counter-productive to the growing middle-class in India (whom the world is partially depending upon to pull many economies in the world from recession)? Will this in turn not reduce the FDI flow to India which will worsen the already bad physical-infrastructure in India?
But if you say, that the interest rates should be kept low for a longer period of time, then will this not push up inflation further as the RBI had pointed out (like adding fuel to fire)?
So, what are your suggestions in this scenario that India is currently facing?
