The Annual Monetary and Credit Policy for the year 2004-05, presented in May by the RBI Governor Dr. Y Venugopal Reddy, clearly indicated a rise in inflation rate for the current fiscal year. The policy also anticipated that
the inflation rate for the year 2004-05, on a point-to-point basis, would be around 5%. However, what it did not anticipate is the sharp rise from 5.55% for the week ended June 5, 2004 to 8.33 % for the week ended August 28, 2004.

An inflation rate close to the two-digit mark can prove to be a threat to the stability of the economy. A high inflation at this juncture is a matter of concern, especially at a time when industrial and agricultural growth is picking up. But the country’s comfortable position in terms of sufficient food grains, favorable forex reserves and monsoon, could improve the resilience of the economy.

The reasons for the high rate of inflation are both domestic and international. The domestic reasons include excess liquidity in the market and delay in monsoon that increased the prices of essential commodities. The international causes are inexorable rise in oil prices, global increase in the prices of commodities, supply side shock and growth in China’s demand for goods.
Huge capital inflows have generated excess liquidity in the market, which has resulted in too much money chasing too few goods. High growth rate and increasing exports and huge forex reserves have also fueled excess liquidity in the market. It is estimated that money supply (M3) has grown at 6% giving an annualized growth rate of 18% between November 2003 and February 2004. Usually, when the growth rate crosses 14%, it is considered as an indicator for concern. The banking industry has also recorded a sharp rise in its net foreign exchange assets from around 26% in March 2003 to approximately 34% in March 2004.