A V Rajwade: Ends and means

A 6.5 per cent inflation rate is not something to panic about.

Having changed, a few months back, the cover design of its venerable monthly bulletin to parallel that of the European Central Bank, has the Reserve Bank also adopted the ECB's single-point agenda of inflation control? In contrast, the US Federal Reserve is responsible for both price stability and full employment. In India, there is no such formal responsibility cast on the Reserve Bank, but comments in the statement issued while tightening the monetary screw once again on March 30 made a pointed reference to the change: "The stance of monetary policy has progressively shifted from an equal emphasis on price stability along with growth to one of reinforcing price stability with immediate monetary measures." Chances are that the deflationary impact of the overvalued exchange rate and the ever-tightening monetary policy would lead to a slowing down of the growth rate. Perhaps, political analysis by the ruling party, of its recent election defeats, blames inflation; growth does not seem to win many votes as the BJP and its allies found to their cost in 2004.

While lip sympathy continues to be paid to how the "poor" suffer most from inflation, the fact is that the articulate, urban middle-class always gets a stronger voice than the silent poor, who are the ones whose interests will be most affected by slower growth and hence lower job creation. Slower growth by 1 percentage point means a drop in output of Rs 45,000 crore""this money is enough to pay a lakh of rupees each to 4.5 million people! In general, our political masters are silent on monetary policy. One exception has been Sitaram Yechury of the CPI (M), who recently wrote: "By making the access to credit costlier, the government may well dampen the investment rates in the economy. This will lead to a deflation and lower growth rates in the future. This, in turn, would mean higher levels of unemployment negating further the objective of inclusive growth" (Hindustan Times, March 29, 2007).

One reason for political apathy could be that much of monetary policy remains cloaked in euphemisms. For instance, the statement dated March 30 says "monetary policy has been engaged in managing the transition to a higher growth path". How does lower credit growth, which the RBI has been assiduously pursuing, lead to "a higher growth path"? Consider again that "[t]he role of monetary policy is to maintain stability and so contribute to growth on an enduring basis". In plain English, what this means is that "we know that our measures to curb inflation may bring down growth in the short run but will support long-term growth (provided credit growth remains, say, 20-25%?)". The first part is a fact, and the second a hope which may not get fulfilled if the economics or "animal spirits" of business do not get crippled. Another stock phrase is "managing liquidity", i.e. curtailing the availability of funds with the banking system for lending purposes.

One is also not quite clear whether "stability", another favourite expression, refers to prices (i.e. a zero inflation rate), or to the steadiness of the inflation rate itself. The fact is that the Reserve Bank's measures have led to a great deal of instability in almost all financial markets""exchange rates, call money, equity prices, etc. Young house owners who borrowed to buy their first flat, and did so at floating rates because there are no fixed-rate lenders, have seen the interest rates rise by up to 3 per cent in the last few months alone. They are not seeing any evidence of "stability". As the EMIs go up, the RBI's own monetary actions would convert its concerns about the safety of housing loans into a self-fulfilling prophesy. There are also any number of contradictions between ends and means. Monetary policy makes housing loans costlier to all and unaffordable to many. But fiscal incentives for house buyers continue. The government recently increased the support price of wheat even when the rise in the prices of primary goods is the single-largest segment of the current inflation. The government is browbeating industry to bring down cement prices, presumably to bring the cost of construction down, even as monetary policy makes it more difficult for the real estate segment to get funding, and thereby increases the cost of real estate. As for manufacturing inflation, I can do no better than to quote from a letter to The Economist (March 24): "[I]t boggles the mind that any sane investor could expect low inflation in the face of oil and copper having risen by 300 per cent in five years; wheat, corn, cement and steel at record levels; and gold, silver, nickel, lead, aluminum, tin, uranium, natural gas and just about any other commodity having rocketed over the last decade" (John Milligan, Victoria, Canada).

It is often stressed that there is no conflict between "growth and moderate inflation". True, but there is clear conflict between continued growth and monetary tightening. "Cooling down" means lowering demand. And this does translate into slower growth. Going beyond the stock phrases in policy announcements, we need to accept that reducing inflation is not a benign exercise; that monetary tightening does lead to lower growth and job creation; that at least some of us would not be able to get the houses or jobs we need; that, as The Indian Express reported last Sunday, many small and medium enterprises are in difficulties because of the cost of borrowing, and some closing down.

The fact of the matter is that inflation is around 6.5 per cent. (Do you know the single-biggest influence on this number? It is the level of the index last year!); this is above the RBI's announced goal of 5-5.5 per cent, and hence the tightening of the screw. What is the sanctity of that number? Is it that 5-5.5 per cent inflation is optimum for real growth maximisation on, say, a three-year time span? Would the RBI take a stand on this? To my mind, a 6.5 per cent inflation rate is not something to panic about; recent measures could reduce the growth rate; like Bibek Debroy, I too would prefer 9 per cent growth and 7 per cent inflation to, say, 7.5 per cent growth and 5.5 per cent inflation, which, incidentally, neatly translates into the 13 per cent nominal GDP growth factored in the budget numbers!