The Hindu Business Line : Confusing signals

So far, the effects of the RBI’s dear money policy have been perverse, the numbers suggesting a lethal strike at output and little effect on inflation.

When the Reserve Bank of India raised repo rates by 25 basis points last Wednesday, the markets took the possibility of more dear money in their stride; in fact, analysts were pretty sure the central bank would follow that up with a hike in interest rates before the month was out. The justification for the repo rate hike was also well known, as the RBI has repeatedly stressed its duty to curb inflation. As if on cue, data on two crucial and related indices immediately foll owed, sending out confusing messages. On Thursday, data on industrial output had some good tidings and two bits of pretty bad news; the good news was that the output grew 8.6 per cent April compared with 2.6 per cent twelve months earlier. The depressing bit was that both manufacturing at 7.5 per cent and consumer goods at 9.8 per cent had fallen dismally from 12.5 per cent and 18.7 per cent respectively in April 2007. Remember, last year’s figures too represented a dip from the one before, which means that the organised economy is showing a declining trend.

Finally, on Friday, inflation had risen to 8.75 per cent (less the retail fuel price hike). The possibility of the general price level inching towards double-digits can hardly be ruled out if the oil price hikes are factored in. So, what would the RBI do? The central bank will do what it must but its actions are limited, as in the past, to liquidity supply adjustments. So far, the effects of its dear money policy have been perverse, as the above data show. The numbers suggest a lethal strike at output and little effect on inflation. More perversely, inflation is rising in inverse proportion to output. That is a scary scenario and one that New Delhi and not Mint Street must address.

So far North Block and other economic ministries seem focused on combating inflation through fiscal measures with mixed results; New Delhi also seems to be hoping good monsoons will dampen food prices. But a government that exuded such gung-ho optimism through its term should not end it on a wing and a prayer. Many more Indians can be better equipped to cope with prices by ensuring greater employment and sustaining incomes through higher foreign direct investments. World growth is entering a long winter but capitalists are not hibernating bears; India offers great opportunities in sectors such as infrastructure, capital goods and retail trade — sectors that will spiral down in the west. Even with pegged-down growth, India still ranks among the shining stars. At $24 billion, FDI in 2007-008 was impressive; but the growth rate has been falling since 2005. That needs reversing fast.

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