The Reserve Bank has repeatedly tightened liquidity for the sake of taming inflation. According to the its last Mid-Quarter Monetary Policy Review in September, “There is a likelihood of inflation remaining high for the next few months, and rising inflationary expectations remain a key risk.” Now, with another review around the corner, the central bank should take stock of its earlier stand. The last policy review also accepts that developments in the global economy are a matter of serious concern, as growth momentum is weakening in the advanced economies.

An important question here is what the outcome of monetary contraction has been on the economy so far. It is evident that the growth is slowing down, while there is no effect at all on the inflation. Many economists, as well as the RBI, argue that monetary policy operates with lags, so the effects on inflation will be seen only in the coming period. Would this really take more than a year to work on price? If so, how did it affect the growth within a quarter? Therefore, without using any econometrics tools one can infer that, at present, growth is extremely sensitive towards the interest rate change, but inflation isn't. Moreover, it is becoming clear that we are in a business cycle, which is characterised by higher growth and galloping inflation.

An analysis of the current inflation reflects that it is mainly flowing from the supply side. Specifically, food inflation, which is the centre of the problem, is mainly caused by productivity infrastructure impediments, poor supply chain management, and untimely decisions in exports and imports. Inflation in manufacturing, which followed food inflation, is also subject to capacity constraints, due to infrastructure bottlenecks in the long run, and in the short run it has been hiked by soaring food prices.

HISTORIC OPPORTUNITY

Meanwhile, the global scenario is adverse, and uncertainty is mounting on the prospects of recovery. If the policy stance isn't reversed, it will take no time to enter a recessionary phase. In addition, one also needs to keep in mind that the global economy isn't going to recover very soon, and hence export earnings cannot be relied upon. The circumstance also compels us to look at the history of the growth of economies and learn from it. It clearly demonstrates that a higher growth cycle is a rare opportunity, and when it has come, we shouldn't let go so easily.

If moderate to higher growth (8-9 per cent) in one phase (2003-07) has made us an emerging power, we can consolidate our importance in the global scene by extending this growth at a slightly higher pace (9-10 per cent). This will not only provide jobs to lakhs of young people, but also provide enough resources to initiate many social welfare schemes, such as NREGA, which may finally help in eradicating poverty. It is also noteworthy that the serious problems in Europe and US are providing India the space for policies to sustain the growth momentum.

(The author is on the faculty of National Institute of Financial Management, Faridabad.)

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