India’s growth slowdown has taken a serious turn. While industrial growth has stayed in the negative zone for five out of eight months, exports have tumbled for eight straight months during FY13. Agricultural growth has suffered, too, due to insufficient rainfall and the ongoing cold wave. However, the severe growth slowdown is not accompanied by falling inflation. India has been facing a stagflation-type situation for several months, primarily due to loose fiscal policy. Whereas headline inflation moderated to a three-year-low of 7.18 per cent in December, retail inflation touched 10.56 per cent in the same month, driven by higher prices of foodgrain.
While the growth slowdown has fuelled expectations of a policy rate cut, the Reserve Bank of India (RBI) governor is reported to have said there was no room for monetary stimulus to boost growth, amid still very high inflation. The question is whether one can expect an optimal policy response from RBI, when faced with sudden fiscal actions motivated by political rather than economic factors. For instance, an increase in the minimum support price of wheat a couple of weeks earlier, even when the country had witnessed record production during FY12.
Ideally, monetary policy should be set on the basis of the expected future state of the economy. Unfortunately, India’s economy is subject to “shock uncertainty”, not only due to natural calamities or global uncertainties (commodity price shocks or global financial crisis, etc) but also to unanticipated (in terms of timing and magnitude) changes in the administered prices of foodgrains and fuels, etc, that mighty influence future inflation in ways difficult to quantify before the event.
Given the gravity of India’s growth slowdown and the fact that core (demand-pull) inflation has moderated to 4.2 per cent in December, a more tactical monetary policy response is the need of the hour. Various ways of adapting policy to allow for imperfect knowledge are available to policymakers. The most common is judgmentally to adjust the pace for policy rate changes without altering the medium-term orientation of monetary policy. The need of the hour is to focus more on employment generation and growth, as the ad hoc nature of fiscal adjustments has compounded the problem of inflation uncertainty for India. We feel a reduction in the repo rate of 50 basis points might to some extent negate the disruptive effects of the painful fiscal adjustments.
(Rupa Rege Nitsure is chief economist & general manager, Bank of Baroda)