The new understanding is that to spur growth, private investment has to be supported

The Reserve Bank of India’s (RBI) decision to hold the policy rates in its mid-quarter policy review last Wednesday is being called “falling behind the inflation all over again” and a “falling out” of Governor Raghuram Rajan and Union Finance Minister P. Chidambaram. It is being said that the RBI’s inflation fight is all set to “lose credibility”.

 After the policy announcement that surprised markets and analysts, Dr. Rajan called the decision a close one and said it is a decision not on hold but to wait for more data. He said though current inflation is too high how it will move in the short term is uncertain. So the call is to act when the inflation trend is better understood. And, to not react to every spike in inflation that, the RBI believes, is temporary.  Latest available official data shows food inflation was growing at 19.93 per cent in wholesale prices and 14.72 per cent in retail prices in November. Government economists say November inflation is a seasonal affair. RBI data shows vegetable prices are climbing down.  As the economy is weak, said Dr. Rajan, the RBI resisted monetary policy “overreaction” at this stage.

 There is an unusually strong forward guidance in Wednesday’s policy statement: If the softening of food inflation that the RBI is expecting does not materialize, it will act before the next due review.

 Could it be that the understanding in the government and the RBI of the inflation-growth task has changed?

 Both Dr. Rajan and Mr. Chidambaram have said in public that high inflation, uncomfortable fiscal and current account deficits and an overheated economy are all unintended outcomes of the stimulus the UPA Government had provided to cushion India against the Lehman collapse-triggered global economic crisis. 

 The stimuli were designed mainly by Planning Commission Deputy Chairman M. S. Ahluwalia, and were announced when Prime Minister Manmohan Singh and Pranab Mukherjee where holding charge of the Finance Ministry.

The new understanding seems to be that to spur economic growth, private investment has to be supported. And, inflation will respond more to fiscal rather than monetary policy. The RBI and the Government seem to be taking these corrective steps now. 

India’s economic growth mid-90s onwards was led by private investment and not government spending-led pump priming.  The best way to support or boost growth in the Indian economy is going to be facilitation and incentivisation of private investment. The RBI Governor, Finance Minister and Deputy Chairman Planning Commission are talking a great deal about the efforts of the Cabinet Committee on Investments to unclog the projects pipeline — something that has resonated well with investment houses in Mumbai.  Then, the government has said it is pressing in spending cuts, including in the social sector, to keep its fiscal deficit within the committed target. These cuts will reduce inflation more effectively as social sector spending puts money in the hands of people who are completely out of the transmission channels of the monetary authority. The RBI’s interest rate hikes so far have been blunt on food inflation though manufacturing inflation is down drastically.

In fact, RBI’s inflation fight has reduced demand for manufacturing products, pushing the factory output growth into negative territory. The latest Index for Industrial Production growth numbers came at -1.8 percent for October. Should new inflation data let the RBI maintain its pause on interest rate hikes, or better still reverse them, manufacturing growth could begin to respond, especially with the government pushing projects.

Inflation, Dr. Rajan is expecting, will get contained by factors such as the negative output gap, the services growth slowdown, the lagged effect of the RBI’s June policy action, the disinflationary impact of the exchange rate stability and, in some measure, the government’s spending cuts. The RBI has long maintained that monetary policy is blunt on food inflation. Dr. Rajan’s predecessor Dr. D. Subbarao had said so in every policy statement. Had the spending cuts that the UPA Government has ultimately been forced into by the fiscal-deficit-ballooning stimulus packages come in earlier, food inflation would not have got out of hand. Interest rates may not have been so high and growth may not have slowed as much. The UPA Government may have woken up to this realisation and mustered the space from the Congress Party for corrective steps a bit too late if the state assembly poll results are anything to go by.


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