The Prime Minister's Economic Council (PMEAC), headed by former RBI governor C Rangarajan, has come out with a bitter truth. It is the government's monetary policy which is giving a wing to the inflation and the government should better reduce the fiscal and revenue deficits to bring it down to the ground.

“The government cannot continue with the kind of large revenue and fiscal deficits recorded in the last two years and will have to initiate fiscal consolidation in the coming fiscal year itself to ensure fiscal sustainability and enable greater flexibility in monetary policy calibration for damping inflation”, the council said in a report which is out a week ahead of the general budget.

The report has issued a stern warning that the runaway prices of the food commodities are likely to drive up the headline inflation next fiscal, putting the government and the RBI under pressure to take policy actions.

"The danger of this spreading to other commodities certainly exists, especially in the backdrop of the strong recovery that the Indian economy has been making since the summer of 2009", the council said, stressing that "policy must remain alive to the danger that a significant transfer of food price inflation to the general price level might occur in 2010-11."

Growth rate up and about: Releasing the council's ‘Review of the Economy-2009-10,’ Dr Rangarajan told reporters here that the Indian economy was bouncing back but inflation was a matter of concern. The review predicted India's growth for this fiscal at 7.2 percent, and later accelerating to 8.2 percent and 9 percent, respectively, over the next two years. 

"Growth may be even higher than 7.2 percent, driven by strong revival in manufacturing and construction," he said while pointing out that the "critical component” of the inflationary process in the current fiscal derives from primary food and sugar.

He dropped hints of the government reducing money supply to curb inflation, taking advantage of high farm production as he said "the council expects a bounce back in agricultural gross domestic product in the next year and maintenance of the desired trend growth of 4 per cent in 2011-12,"

The high-profile council's recipe tallies with that of RBI Governor Duvvuri Subbarao, who too said last month that monetary policy alone wouldn't be effective in containing inflation unless finance minister withdrew fiscal stimulus measures and narrowed the difference between spending and revenue.

The council expects the industrial and service sectors to continue to expand strongly in the next two years and hopes the government's priorities and initiatives on infrastructure would proceed along desired lines. "On this basis, we are making an initial estimate that the economy would grow by 8.2 per cent in 2010-11 and by 9 per cent in 2011-12," said Rangarajan.

He attributed the rising growth rate to strong rebound in the second half of 2009-10, with all signs of strong rebound also in the third and fourth quarters, especially in industry. He said outcome in the farm sector will be also much better than feared earlier, in part due to proactive government measures.

Global scene: Comparing happy recovery in India with that of the developed countries, he said they had come out of recession but it was a weak recovery with downside risks to growth, more so because the financial markets were nervous about fiscal sustainability, worsening budgetary position in advanced economies and speculative pressure on commodity prices, especially the sharp rise in crude oil prices.