'There is no growth-inflation tradeoff'

Q&A/ Chakravarthi Rangarajan

Chakravarthi Rangarajan, 75, is one of the three key economic pundits in Prime Minister Manmohan Singh's government (the others being the PM himself and Planning Commission deputy chairman Montek Singh Ahluwalia).

As the head of the Economic Advisory Council, Rangarajan advises the PM on economic policy and suggests policy responses. Siddharth Zarabi and Asit Ranjan Mishra asked him a number of questions including whether curbs on capital flows are necessary and what was an ideal level of inflation for a fast-growing country like India. Excerpts:

How do you view the economic scenario in the country?

I think the economy did exceptionally well last year with a record GDP growth of 9.4 per cent. One could expect some moderation in the current year. But when we talk of moderation, we are not talking about a large shortfall in growth.

Growth is a marathon race. Some slowing to gather further speed is natural. If the monsoon is good and the external environment is also more conducive, we can almost have another year of 9 per cent growth. These are some imponderables at this particular stage. Perhaps by July end, one can have a better picture of likely GDP growth. In my view it will not come down below 8.5 per cent. Most probably, it will be 9 per cent.

Is India a trillion dollar economy?

I think we are a trillion-dollar economy on the basis of GDP at market prices. In fact, using the current exchange rate only underestimates the size of the economy. Certainly we are third or fourth largest in the world in terms of size.

Your question arises from your feeling about per capita GDP and per capita income of our country. It is true that we are not even a middle-income category country. But size also counts in the global scene. We are not only a large economy, but also one growing at 9 per cent.

What is being done to prevent structural overheating in the economy?

In the case of India, a greater part of growth is now being driven by investment. Initially, it may create a situation in which prices will rise, but subsequently as new capacities are created, there will be a dampening impact on inflation and overheating. To some extent there has been an abatement of overheating now. In many sectors of the economy, investment is adequate to create the needed additional capacity.

However, it is not happening in infrastructure, more particularly in power. That is where the structural imbalance comes in. If this is not taken care of, then overheating may continue. Many power projects, where work is under progress, would come into operation in the first three years of the 11th plan (2007-12). This will add considerably to capacity. So, in the meanwhile, we have to see that power availability does not become a serious constraint for growth.

Do you believe a trade off exists between inflation and growth?

This is a false dichotomy. In my view, over the medium term there is no conflict between lower inflation and higher economic growth. In fact, higher economic growth can be sustained only in an atmosphere of reasonable price stability. Price stability is required for promotion of savings and investment. Sometimes there could be a conflict in the short run. But, that should not be utilised as an excuse for letting inflation go out of hand.

Why do we use the WPI as the major inflation indicator, when it does not reflect consumer price levels?

In the National Statistical Commission, of which I was the chairman, we pointed out two things; one is restructuring of the WPI because it reflects only the prices of goods and the impact of services is not reflected. Second is the need for a composite consumer price index (CPI) because at present the CPI is available only for different consumer segments.

Hence, we need a consumer price index which is a general CPI. Having said that, we use the WPI as the data is available without much lag. Secondly, except in years in which primary article prices have risen fast, in all other years the difference between WPI and CPI is not very big. However, I agree that we need to release data on CPI also with a shorter time lag. But we are not very far off from understanding how prices are moving by using the WPI.

Given that inflation is declining, is there a case for a decrease in interest rates?

Well, that depends totally on the way inflation behaves. The signs at the moment are that inflation would moderate during the year. And my own surmise is that as the inflation rate moderates, there will be no need to raise the rate of interest.

The RBI needs to have convincing evidence that the inflation level is coming down and it is being sustained at that level. The actions of the RBI were directed against the rise in prices. If the RBI feels confident that the inflation rate is coming down and the trend continues, then I am sure they will take appropriate action.

Are more steps needed to curb capital inflows?

We have to look to at this whole problem in a holistic way. There are three channels through which policy makers can act (in case of a high capital inflow scenario). One is to let the rupee appreciate. Second is, to let the capital flow come into the country and sterilise it to the extent needed, but there is a fiscal cost to it or banks will have to bear the burden. The third is to act at the source itself and put some restrictions on capital flows.

Any restriction on capital flow should take into account that it is not a reversal of policy of liberalising the external sector. Instead of arguing for any one of the instruments to be used, I would argue for a judicious balance of all the three instruments. There are limits to which each instrument can be used.

Are the curbs short-term measures. Will they be reversed?

Yes, I hope so. For example, in case of the external commercial borrowing (ECB), we have always operated with some ceiling. But these ceilings are not always hard, rather they are flexible. ECB was at a fairly high level last year.

In the current year, there could be an effort to keep it somewhat at a lower level. Therefore, the intention should not be to put permanent restrictions on capital flow. It should be done as a temporary measure under the present circumstances.

What is an ideal level of inflation?

This inflation question has been discussed for a long time. The Chakravarty Committee, of which I was a member, had indicated 4 per cent as an acceptable level of inflation on a long-term basis. I had also introduced at one time the concept of threshold level of inflation.

It is the level of inflation beyond which the adverse consequences are strong. Such a level of inflation cannot be fixed at one level for all times. It also depends on what the rest of the world is doing. If the rest of the world is gearing towards a rate of inflation of 2-2.5 per cent, we cannot have an inflation rate well above that rate. Therefore, about 3 to 4 per cent is an acceptable inflation rate for the medium term. For now we should be gearing towards 4 per cent inflation rate.