The surge of hope generated by the first quarter growth numbers (5.7 per cent) has ebbed somewhat. Industrial production data for July recorded an annual growth of a measly 0.5 per cent. Worse, output of capital goods fell year-on-year by 3.8 per cent while consumer durables registered minus 20.9 per cent. While there are indications that overall business sentiment is looking up, we are still some distance away from a recovery and urgent steps need to be taken to revive investment appetite. The new government at the Centre has demonstrated little appetite for big bang reforms, which are necessary to convince investors, both domestic and foreign, to take up greenfield projects. One waits to see whether the conclusion of the Assembly elections in Maharashtra and Haryana next month will spur it into action.

The Centre cannot expect much help from the Reserve Bank of India (RBI) in helping to reverse the slowdown, which is more than three years old. An interest rate cut can be virtually ruled out in the next monetary policy review on September 30 with retail inflation at 7.8 per cent in August, still well above the comfort zone. Of course, inflation principally arising out of supply bottlenecks rather than excess demand cannot be tamed by raising interest rates. In this case, high interest rates may have reinforced inflationary pressures by raising costs for industry — this seems to be the experience of the last three years. The RBI faces another constraint: if India is to remain an attractive destination for debt flows, it needs to keep its rates attractive, notwithstanding the rate cut by the European Central Bank. Add to this the threat of the reversal of the US’ easy money policies and it is apparent that the RBI cannot realistically be expected to go in the opposite direction — unless, of course, the current account deficit narrows dramatically, which is not going to happen suddenly.

The Government, therefore, is in an unenviable situation of having to revive industry without lowering the cost of domestic credit. Concern over deficit levels means there is no leeway for fiscal stimulus either. But this is no cause for despondency. The Government can still do a lot in the form of supply-side reforms — from rationalisation of subsidies to the implementation of the Goods and Services Tax. While our flexibility on the fiscal and monetary fronts is cramped, quick decisions that display a firm resolve for reform can go a long way towards improving business sentiment. This could well provide a more powerful stimulus to the economy than conventional fiscal and monetary instruments.

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