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The positive impact of the three fiscal stimulus measures is at the risk of being undone, taking the already sluggish economy down the slower growth path.

The way the government handles the rise in primary articles is going to be the key determining factor for the economy over the next few years.

Prices of primary articles have been on a steady upward path, leading to the primary article index rising an annualised 11% in the first four months of this fiscal (April-June 2009).

The index has a 22% weight in the wholesale price index (WPI), the widely used benchmark by Reserve Bank of India (RBI) for determining policy rates.

The worsening monsoon situation with rains playing truant in June and the first week of August is impacting supply of primary articles and increasing the expectations of rise in prices.

The situation is worrisome for the government, which has raised fiscal deficit target to 6.8% of GDP (highest among emerging economies) while RBI has cut policy rates to all time lows and created high system liquidity to combat recessionary forces.

The combined efforts of the RBI and the Government is yet to take full effect with credit growth still sluggish at 15.5% and aggregate demand yet to pick up as seen in the decline in revenue growth of Sensex companies by just below a percentage point for the first quarter of fiscal 2009-10.

The last time inflation rose on the back of rise in global commodity prices and on the back of food prices, the RBI raised policy rates and kept liquidity tight to in order to curb inflation.

This was in June 2008 and on the back of RBI policy actions the economy fell sharply with demand going out of the economy on the back of high interest rates and tight liquidity conditions. This time around with the economy still sluggish any withdrawal of policy accommodation on the back of food price inflation will take the economy back by many years. The RBI governor in a recent speech has said the following “ Food items which have a large weight (46 - 70 per cent) in the various consumer prices indices are vulnerable to large supply shocks, especially because of the vagaries of the monsoon, and are therefore beyond the pale of monetary policy. An inflation targeting RBI cannot do much to tame a supply driven inflation except as a line of defence in an extreme situation”.

It is important that RBI walks the talk and comfort jittery bond markets which have been faced with inflation worries on the back of accommodative monetary policy.