The Reserve Bank of India Governor recently said the inflation rate was still at unacceptable levels and efforts should be made to rein in prices further to provide relief, especially to poor people. This has led to speculation that the RBI may continue with its hawkish stance in the forthcoming October review of monetary policy.

A counter-question one can pose is whether growth is not necessary to increase supplies of goods and services that, in turn, could provide relief to the poor. In this regard, a profound statement from H.R. Khan, RBI Deputy Governor, is worth noting.

He has said that presently, in view of the continuance of low inflation and low or negative growth in the developed economies, policy measures, mainly in the form of liquidity enhancement and low interest rates, continue to focus on augmentation of growth.

In India, however, the conditions are very different. Along with economic slowdown, inflation is ruling significantly above the threshold level, beyond which inflation turns inimical to growth. Under the current macroeconomic environment, Indian policy makers have to think of various measures that can simultaneously achieve the twin objectives of higher growth and lower inflation.

The word ‘simultaneously’ is important. He has not particularly said that inflation should first be brought down before growth picks up. The experience in the last decade was that high growth rates, sustained over a substantial number of years, helped in reducing poverty.

While inequality still prevails, different estimates show that the percentage of population below poverty line fell as a result of the high growth phase.

The recent experience also shows that while growth rate has taken a consistently dangerous downward path, taming inflation has not been a successful endeavour. While the argument that inflation beyond a point is inimical to growth is understandable, can growth below a certain level also not induce inflation, looking at it from the supply side?

In the current situation, if inflation continues at unacceptable levels, the fall in growth to equally unacceptable levels should be viewed very seriously.

Growth-Inflation Puzzle

If we divide the last decade since 2000-01 into two periods — till 2008-09, and thereafter — it throws up some useful insights. Growth was reasonably sustained at relatively higher levels, with wholesale price inflation at reasonably low levels in the first phase. During this period, while high growth rates were associated with low inflation, it is very difficult to answer whether low inflation contributed to high growth or high growth contributed to low inflation.

Since 2009-10, while inflationary pressures have increased, one can also argue that the slowdown in growth has further accentuated inflationary pressures. One interesting statistic is that in the 32 quarters between 2000-01 to 2008-09, growth rate exceeded inflation rate in as many as 23 quarters, and only in nine quarters did the inflation rate exceed the growth rate.

Strangely, in as many as 13 of the 17 quarters between 2008-09 and the first quarter of 2012-13, inflation exceeded the growth rate, and only in four quarters did growth exceed the inflation rate.

Secondly, during the period, till 2008-09, while movements in growth rate and inflation rate showed a negative association, as argued earlier, it is a puzzle whether higher growth rate led to lower inflation or lower inflation to higher growth. From the graph that plots movements in GDP growth and wholesale price inflation rates, there seems to be some kind of a contemporaneous relationship between the two.

The story from 2009-10 becomes somewhat different. There is a fall in growth rate, but the inflation rate remains persistently at higher levels and also well above the growth rate in GDP.

Since there is an associated relationship between higher growth and low inflation, it is worth giving a thought to whether providing a stimulus to growth through both demand side and supply side measures, at this stage, will contribute to an accelerated fall in inflation rate. Since inflation is downward-sticky with some kind of assumed inertia, this gamble seems to be worth taking.

Monetary and Credit Side

Two important things set apart the period from 2000-01 till 2008-09, from the one that follows, from the credit angle. First, the average non-food credit growth was 22.9 per cent between 2000-01 and 2008-09, touching nearly 30 per cent during the very high growth phase from 2004 to 2008.

This was particularly enabled by banks making portfolio adjustments, shifting their preference to credit over investments in government securities. This was facilitated by the government implementing fiscal consolidation that helped ‘crowd in’ private investment. The position is almost reversed now. Non-food credit growth has come down sharply to 18.4 per cent since 2009-10. In view of several constraints, banks are making portfolio adjustments in favour of investments over credit. Hence, fiscal policy is crowding out private investments.

Second, the interest rate conditions till 2008-09 remained relatively easy, since the system was almost continuously kept in a surplus condition as reflected in the RBI being in liquidity absorption mode.

The short term rates were hovering around the lower bound of the interest rate corridor set by RBI. The benchmark prime lending rate (BPLR) system also allowed banks to lend at below BPLR rates, which were found attractive by the corporates.

In the recent past, the situation has reversed. The system is mostly in liquidity deficit mode, with the RBI also turning to liquidity injection mode. The short-term interest rates are now hovering around the repo rate, the higher bound of the interest rate corridor. The repo rate is also kept at high levels.

The political climate and governance conditions, and congenial external sector environment, also helped sustain the growth process till the onset of the global financial crisis.

The situation has taken a turn for the worse, till recently when government has shown some courage to go ahead with much-needed economic reforms.

Looking Forward

Viewing the simultaneity factor between growth and inflation, the RBI should take a chance — stimulate growth by creating easy credit and interest rate conditions, without waiting for the inflation rate to come down.

The push to growth, in turn, can accelerate the process of inflation easing. On the other hand, if the RBI waits for inflation to come down, then growth may get further worse, resulting in a low-growth, low-inflation trap.

Inflation coming down to acceptable levels on its own, or by maintaining a hawkish stance, cannot happen in the immediate future. Since the government has taken the much-delayed step to push reforms, the RBI should also show a more positive response to revive investor confidence, both within India and from abroad.

(The author is Director, EPW Research Foundation. Views are personal. blfeedback@thehindu.co.in )

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