Double-digit inflation over the last few years, a result of the government’s own excessive spending, has undermined the rupee’s purchasing power. Indians have responded by looking for a hedge in gold, stepping up their purchases of the imported yellow metal to an annual $60 billion pace. That’s one of the reasons the current account deficit widened to an unsustainable 6.7 percent of GDP in the final quarter of 2012.
The citizens’ gold habit irks the government and the central bank. While Chidambaram has now pledged to reduce the budget shortfall, he has no way of knowing if people will view his promise as trustworthy. After all, his boss Sonia Gandhi wants to launch a costly entitlement programme that would guarantee the poor’s access to heavily subsidized food ahead of the 2014 general elections.
In theory, “linkers” can enhance the credibility of the government’s commitment to low inflation. That’s because New Delhi’s borrowing costs will rise if it allows prices to spiral out of control after selling inflation-protected securities. Read More