The policy challenge

The high oil prices prevailing so far this year, and the forecast that prices will remain firm for the foreseeable future, mean that India will lose something approaching 2 per cent of its GDP this year to the guys who sell India crude. This cannot but have downstream economic effects.

Most obviously, as the import bill climbs, India is about to end its three-year run of current account surpluses. The current account deficit will be small and manageable, of course, given the capital account inflows and the abundant dollar reserves.

Nevertheless, all those who thought the rupee would be on the ascendant have already realised that this is not true. The rupee has fallen by about 6 per cent against the dollar in the past three months, and could drop further.

While this will mean importing some price inflation, it will help many domestic producers who compete against imported competition, and also deliver better profits to export-oriented sectors like software.

The other significant result is inflationary pressure; wholesale price inflation has already nudged the 6.5 per cent level, and as domestic petro-product prices get jacked up, that number should be expected to climb.

If anyone entertained hopes about interest rates falling further, those hopes must be long dead because the "real" interest rate (after adjusting for inflation) has reached reasonable levels. Many long-term housing loans have been given out at barely 1 per cent real rate of interest.

This cannot last; interest rates have hit bottom and should at some stage be expected to climb, even if slowly because there is no shortage of liquidity in the system.

Throw in the drought and the short point is that the macro-economic environment today is quite different from what existed six months ago. On all previous occasions when high oil prices combined with a drought, there was an economic crisis.

Fortunately, the economy today is more resilient than in the past""there is no shortage of food stocks, for instance. The policy challenge therefore will be to get to grips with the new reality and sustain the growth momentum.

Growth expectations have already been moderated by most people, and the 7.4 per cent top-end limit of the finance minister's growth expectations for the new year is now beyond the pale of the possible.

If agricultural growth is likely to be close to zero, then the upper GDP growth marker should settle around the 6 per cent level. Even that wouldn't be bad going in a drought year, given that the average growth rate in the past six years has been less than this.