The latest data on inflation for the week ended July 24 has caught most people by surprise. As recently as May, when the Reserve Bank of India presented its credit policy, inflation for the year was projected at 5 per cent. Now, it turns out, prices have been galloping since. Prices of the 435 commodities that make up the Wholesale Price Index (WPI) have jumped 7.51 per cent, a three-and-a-half-year high, compared to a 6.52 per cent increase a week earlier. What's behind the sharp jump (it's not usual for inflation rates to soar a whole percentage point in a matter of seven days)? A blend of factors, both domestic and global. Poor rains in most parts of India have pushed up prices of food commodities, besides which crude oil prices have been clipping. The latter may have played a bigger role, simply because it affects the prices of everything-from manufactured goods, which make up 64 per cent of the WPI, to food products.

What does a vastly higher rate of inflation mean for the economy? If you've been watching key indicators such as the stockmarket and the money market, you would have figured out the answer by now, and which is that both manufacturers and consumers, not to mention equity investors, hate high rates of inflation. The consumer bit is easily understood. For industry, higher rates of inflation mean that interest rates will, sooner than later, go up. It's a no-brainer what more expensive debt means to companies: the cost of their investment goes up, making it harder for them to earn profits on those investments. The only way they can ensure profitability of their new expensive investment is by pricing their products higher, but the problem in doing so is that it only further fuels inflation. In such situations, therefore, industry reacts in a typical way: it simply withholds fresh investment.

Things get a little tricky hereafter. To curb inflation, central banks usually increase the rate of interest. The logic being that more expensive capital will discourage its offtake and hence restrict supply of money into the system. You don't have to be a genius to figure out what happens when there's less of money and more of goods and services in the marketplace. As the law of supply and demand dictates, the prices of the latter set must come down. But here's the problem as far as the Indian economy is concerned: banks are already sitting on a pile of cash, and the demand from industry is at best modest. If the RBI were to increase the rate of interest at this juncture, it runs the risk of stifling whatever little investment-and the resultant job creation and growth-that is taking place at the moment. No doubt for that reason, the central bank has said that it is in no hurry to hike interest rates (never mind that it will hurt small investors who park their money in fixed income securities).

Where does that leave the economy? If rains elude the remaining two months of the monsoon season, agricultural production will almost certainly take a knock. In fact, a report by CRISIL indicates that agricultural production will shrink by 2.5 per cent this year, although industry and services are expected to grow 6.8 per cent and 8.4 per cent, respectively. Overall, the GDP is expected to grow only 5.6 per cent against the government's projection of 6.5 to 7 per cent. Could things get worse than that? Unlikely, but don't bet on it. For one, oil prices, up 37 per cent so far this year, are showing no signs of cooling off. On the contrary, it may touch $50 a barrel by the end of this year. A modest rate of inflation (like the 3 to 4.5 per cent we've had the past two years or so) is actually good for the economy, since it allows relative adjustment of prices, but a runaway inflation can do a lot of damage. The latest inflation data does not suggest any imminent danger to the economy. However, it's quite apparent that it is out of its comfort zone.