For a brief moment let us suspend belief and imagine that all the money in the country is just Rs100. And all the goods produced in the country are just five apples. Naturally, each apple will fetch Rs20. Next year, the money doubles to Rs200 but the total goods produced are again five apples. Each apple will now fetch Rs40. That is what inflation is all about - too much money chasing too few goods.

Inflation is a hydra-headed monster, which has a desirable as well as an undesirable effect. The desirable part is that when prices are high, businessmen get more value for their goods, which entices them to produce more. The undesirable part is that when prices shoot up, people are forced to restrict their purchases, which can lead to recession.

The government released the inflation figures for the week ending July 24, which clocked a 42-month high of 7.51 per cent. For the week ending July 31, the figure was 7.61 per cent. There is more to come as prices of petrol and diesel were increased after midnight July 31 and everyone is waiting for the education cess to come into effect.

Inflation in India is calculated on the basis of the wholesale price index (WPI) and that is now showing a figure of 7.61 per cent. Therefore, inflation, if reckoned on the basis of the consumer price index (CPI), will be higher and ultimately it is this price, which the citizen pays, that pinches.

This has caught the Reserve Bank of India unawares and has the government shaken and stirred - though it will not admit it. After all, it was the rising prices of onions, which felled a government and elections in the important state of Maharashtra are round the corner. Besides, rising prices will provide a potent weapon to the opposition - now in a state of disarray after the shock of being hustled out of office - with which to stir anti-government sentiments. The Left parties, on whose support the UPA government survives, will also have a new sting to its anti-liberalisation stance.

Though the worms have come out of the can only now, inflation had actually begun in April, this year, but was kept tightly under wraps by the previous BJP-led government, to prop up its 'India shining' campaign for the impending elections.Unfortunately for itself, the UPA government will have to bear the cross of rising prices.

Rising oil prices have been one of the main causes of inflation though that is not all. A weak monsoon till recently brought about a shortage in food items and some commodities. There had also been a surge in foreign exchange inflows and to keep the price of the rupee stable, the RBI has been purchasing dollars - and that means pumping in rupees into the system.

To suck out the excess rupees from the system, the RBI follows a policy of sterile intervention - which translates in to the RBI issuing government securities. There is a limit to the quantum of government securities the RBI can issue and its stock of securities at the moment is insignificant.

The RBI can also increase the cash reserve ratio (CRR), which is the amount of cash maintained by commercial banks with the RBI. At present, the CRR is 4.5 per cent. For the sake of better monetary management, the government is committed to bringing down this ratio to 3 per cent by April 2005, so nothing much can be done on this front.

The RBI can tighten the monetary policy by raising interest rates, as was done by the US Federal Reserve and the Bank of England. However, higher interest rates will hit the balance sheet of banks that have large interest rate exposures. Moreover, the RBI is also the banker to the government by virtue of which, it tends to keep the interest rate low so that the government's interest cost remains in control.

The government is caught in a huddle, which is why we saw a flurry of meetings between the RBI governor, the finance minister and the prime minister. Finance minister P Chidambaram has also gone to the extent of 'warning' manufacturers not to raise prices of commodities.

To reassure the public, Chidambaram said, "Action can be taken in a measured manner both on the monetary and fiscal side. While the RBI will take action according to its judgment on the monetary side, the ministry of finance will look at options on the fiscal side."

A committee on prices headed by the prime minister, with seven cabinet ministers like Pranab Mukherjee and Sharad Pawar, has been formed. The committee will also have the deputy chairman of the planning commission, the widely-respected Montek Singh Ahluwala, as a special invitee.

The government's strategy is to watch and monitor prices closely and bring in monetary changes like changes in interest rates and fiscal measures like reduction of duties.

The prime minister, finance minister, the RBI governor and members of the committee on prices are, fortunately, experienced administraators capable of handling the price rises, which has taken them by surprise. And they better do it fast, or else heads could roll.