Growth will slow down and inflation will only rise.
While the ruling coalition won the vote of confidence last week, it does nothing to ameliorate the major problems at the macro level. Media comment has speculated the restarting of the reform process — this however seems unlikely. Rightly or wrongly, economic reforms are not considered a vote-gathering tool in pre-election months, and the general election will be due in the first half of 2009. This apart, economic liberalism is hardly a matter of conviction for most of the Congress Party netas — and surely the leadership has exhausted much of its credit in mustering the party and its allies to support the nuclear treaty.
In the meanwhile, major problems remain — growth will be slowing down because of both domestic and global conditions, even while inflation remains at around 12 per cent. This number also should be taken with a pinch of salt because of the following reasons:
Clearly, the RBI Governor has a daunting agenda at hand as he finalises tomorrow’s monetary policy statement.
One positive feature, as far as the prospects of inflation are concerned, is that oil prices have softened in the last couple of weeks — to around $125 per barrel. But it would still take a bold man to see in this the beginning of a trend towards lower prices. This apart, I would also not rule out the possibility of President Bush authorising or encouraging an air attack on Iranian nuclear facilities in the remaining months of his presidency. Any such adventure would surely take the oil price to new peaks.
In its recently-released World Economic Outlook (WEO), the IMF has forecast a moderation in global growth and a simultaneous increase in inflation. AS the WEO says: “The global economy is in a tough spot, caught between sharply slowing demand in many advanced economies and rising inflation everywhere, notably in emerging and developing economies … In many emerging economies, tighter monetary policy and greater fiscal restraint are required, combined in some cases with more flexible exchange rate management”.
It is worth spending a couple of minutes on the three remedies suggested by the IMF. As readers of this column may recall, I am something of an agnostic on the efficacy of monetary policy in influencing prices — unless tightening is carried to extremes. This is also implicit in the belief that many monetary policy decisions are aimed more at influencing (“anchoring”) inflation expectations than the price level itself. Recently, Ben Bernanke, Chairman of the US Federal Reserve, was frank enough to admit “gaps in knowing” how exactly central bank actions affect expectations and how the latter affect inflation. (This admission, to my mind, is at par with what Mrs. Thatcher’s first Chancellor of the Exchequer confessed in his memoirs. The Thatcher administration started with great faith in monetary aggregates and their ability to steer a path of non-inflationary growth. The Chancellor later confessed that, very soon, they were totally confused about the implications of various monetary aggregates, about what exactly they measured, and their impact on prices.) Nevertheless, one still expects some monetary tightening given the level of inflation. However, now that the electorally-important middle class has also become a large borrower of housing loans, a significant increase in interest rates is unlikely.
Should exchange rate appreciation be resorted to as being advocated by some? I hope not. First, the pass through impact of exchange rate appreciation on prices is limited. Second, we could be looking at a current account deficit of 4 per cent of GDP in the current fiscal year thanks to increasing oil prices, and slower growth in both goods and services exports — and this at a time when portfolio capital flows have reversed. Do you know who has borne the cost of rupee appreciation? The temporary workers in Tirupur who have lost jobs, the diamond cutters and polishers in Gujarat whose wages have come down by a third and their counterparts in other SMEs.
To add to the woes of the macro economy, the fiscal situation remains weak. In fact, this was the reason for change in the outlook for India’s domestic currency rating by rating agency Fitch a couple of weeks back. Properly measured, inclusive of the various off-budget bonds, the deficit may well add up to to 8 per cent of the GDP. It is ironic that this should happen when economic policy-making is being led by the “dream team” comprising the prime minister, the finance minister and the deputy head of the Planning Commission.
