The central banker of an emerging economy has the unenviable task of striking a balance between growth and inflation. They must not kill growth in the war on inflation. RBI Governor D Subbarao is one such governor. He represents the central bank of a leading emerging economy, where inflation is crawling up while growth is decelerating. On June 16, he made his mind clear when he had observed, “some short-term deceleration in growth may be unavoidable in bringing inflation under control and the RBI needs to persist with its anti-inflationary stance.”
What is noteworthy, however, about his ‘anti-inflationary stance’ is the small steps he takes, so that growth is not hurt. For this, he has earned criticism. According to critics of the baby steps, in the last 15 months the repo rate has been increased 10 times, by a cumulative 2.75 percentage points, but with little effect on inflation. There is, accordingly, a suggestion that RBI needs to re-think its strategy. However, such an assessment is misplaced.
So far, inflation was being driven largely by food and commodity prices, and RBI action could have had very little effect. Naturally, inflation was inching up, in spite of many hikes in the policy rate. Like central banks everywhere, the RBI had to take small steps to express its concern and readiness to act. While big steps could be damaging, baby steps could be intimidating. Further, so long as inflation was seen as a supply side constraint, there was no point in RBI displaying its killing spirit.
The context has changed now. Commodity price inflation has spread to manufactured products and is pushing core inflation. Couple this with food price inflation, and there is the risk of a wage-price spiral. Further, oil prices are posing a serious threat. If the government allows a full pass-through of the rise in oil prices, headline inflation would hover around the double-digit level and seriously cripple growth. Given this, it is time to declare war on inflation, before it spins out of control.
It is rightly felt that in the war on inflation, growth can wait. The RBI governor has once again increased the rate by only 25 basis points, but at 7.5 per cent the repo rate is sufficiently growth-constraining. Further hikes will follow if the present action is not seen to be effective enough.
However, the question of trade-off between inflation and growth still remains. We cannot ignore the interests of growth, as otherwise there is the risk of stagflation. Growth must wait at a level the economy can live with. What is that level where we can ask growth to wait and not fall further? What is the degree of freedom for the RBI with regard to rate hikes? What is the limit beyond which the rate should not be pushed further? It is difficult to answer such questions, but a realistic assessment of the current situation may be useful.
The global economy is once again in crisis, with the advanced economies standing on the precipice of stagnation. We, in India, cannot escape the effect of the crisis. The RBI governor is right in pointing out that “recent global macro economic developments pose some risks to domestic growth.” What he means is that our GDP growth will be affected in any case, and the situation may be worse if inflationary trends remain unabated. The question is, to what extent we can sacrifice growth and still retain the growth momentum?
During the crisis of 2008-09, our GDP growth had fallen to 6.8 per cent, but then, with the onset of recovery, it went up to 8 per cent in 2009-10 and 8.5 per cent in 2010-11. The slowdown fever had, however, started, beginning in the second half of the last fiscal. In the fourth quarter of 2010-11, GDP growth declined to 7.8 per cent, from 8.3 per cent in the previous quarter. In the current year, no one, including the RBI, expects growth to be above 8 per cent. But it is imperative that we halt the deceleration, as we also try to contain inflation. It is important that we also provide a cover for the economy to achieve the minimal expectation of 8 per cent growth, or around 8.5 per cent.
Take this as the benchmark for the current year. Will this be difficult to achieve, if the RBI goes in for a further rate hike of, say, 25 or 50 basis points? In my view, the RBI can have this leverage in controlling inflation and we can still have more than 8 per cent growth, provided some care is taken to ensure that the business environment is not disturbed and business confidence is boosted.
At this moment, when the RBI has to perform its role, the government must ensure that the economy runs smoothly in spite of various anti-corruption drives and civil society movements. All centrally sponsored schemes need to be carried through in earnest so that resources allocated for the purpose are fully utilised. Intelligent fiscal consolidation also helps. It is also important to ensure that infrastructure projects are not hampered due to lack of clarity and uncertainty on matters relating to land, environment, forests, rehabilitation, etc. Such matters have been seriously hurting the investment climate in the country, and are contributing to the slowdown.
On their part, commercial banks should be judicious in credit allocations. They may pursue a discretionary policy on supply of credit and lending rates. They have a critical role to play in this moment of crisis. Interest-sensitive but employment-intensive sectors (such as small and medium enterprises) can be spared the full rigours of the credit squeeze and the burden of high lending rates. In the war on inflation, the RBI and commercial banks can work in partnership. While the former controls inflation, the latter can protect growth.
The author is President, JK Organisation, New Delhi
