The industrial production numbers for July confirm the slowdown in tempo, with the month’s growth in output at 3.3 per cent being the slowest in two years. Growth during April-July has averaged a sub-par 5.8 per cent. For good measure, the total flow of financial resources to the commercial sector (including non-food bank credit) has grown by barely 2.5 per cent in the first five months of the financial year, noticeably slower than the 4.5 per cent increase during the same period last year. This is not for want of resources, because bank deposit growth has accelerated. The problem, therefore, is likely to be poor demand for funds.
These trends sharpen the choices facing the Reserve Bank of India (RBI), which is due to review its interest rate structure on Friday, because inflation is where growth was supposed to be (nine per cent). RBI has been clear so far that inflation is the bigger problem and, after some initial dithering, has taken tough action. The new data on industrial output will almost certainly make it think hard about the way forward, even as a chorus of voices encourages RBI to stay its hand on Friday. Those who would want RBI to announce a pause in rate hikes (and in the last round this included the majority on its own technical advisory committee) will point not just to the growth-discouraging consequences of a dear money policy, and specifically to the drying up of investment that has already occurred, but also to the deterioration in the global economic environment since RBI’s last policy review, six weeks ago. While there is obvious merit in these arguments, the dilemma for RBI would be that, by holding back action now, it may wrongly suggest that it is no longer worried primarily about inflation at a time when there is no clear indication that the price rise has peaked. A possible reversion to rate hikes six weeks later would then look like a confused response. Damned if it does and damned if it doesn’t, RBI may prefer to be damned for doing what it is already committed to, ie taming inflation.
Indeed, RBI’s hand may be forced by the fiscal slippage that is now on display. The subsidy bill is likely to be much larger than budgeted, and some revenue assumptions (as on disinvestment and spectrum sale) may not be borne out. An expansive fiscal policy (with a deficit well in excess of the budgeted 4.6 per cent of GDP) combined with an accommodative interest rate policy is not anyone’s idea of good macro-economics when inflation is close to nudging double digits. The point of course is that RBI is not the only agency that is tasked with controlling inflation; nor lower interest rates the primary corrective for the slowdown. The government will have to look at how the second half of fiscal 2011-12 can be salvaged, and the original budgetary parameters honoured to the extent possible. This would require determined action on the part of the finance minister. There is great wisdom in three familiar phrases: money does not grow on trees, a stitch in time saves nine, and one must cut one’s coat according to the cloth!
Inflation can also be tamed by getting rid of supply bottlenecks. Power producers fret about the lack of coal, and steel plants in Karnataka are in trouble because the state’s iron ore mines have been ordered shut. There is also lack of clarity about the future of a key element of export promotion, while uncertainty about legislation on mines and land acquisition tempts businessmen to hold back investment. On top of everything else, the fractious political climate upsets business and perhaps even consumer sentiment. However difficult the economic situation, though, it does not warrant business confidence dipping below the levels that prevailed post-Lehman, in the latter half of 2008-09. If the problem is part psychological, as it would appear to be, the government has to get rid of the impression that it is under siege. The only way in which it can do that is by demonstrating through reform measures that it does have an active agenda.