The recently-released numbers show that headline inflation has started to edge up (6.1 per cent in August), after moderating since March this year. What does it mean for growth of the economy?
The central bank has to do a tough balancing act, managing growth and inflation. The RBI has, on various occasions, pointed out that upside risks remain to inflation. Some solace can, however, be derived from thefact that the WPI growth rate this year is lower when compared to the same period last fiscal.
On the economic growth front, an improvement is expected but the recovery is likely to be slow. The meagre 4.4 per cent GDP growth in the quarter ended June 2013 has been the lowest since the March 2009 quarter.
Last week, the Prime Minister’s Economic Advisory Council scaled down its growth projection for 2013-14 to 5.3 per cent, which too has been contested by many economists.
The latest update on inflation, spells further risk for the already fragile growth,if we go by the RBI’s threshold level of inflation.
Inflation rate
The conventional view on the relation between growth and inflation suggests that there exists a trade-off between the two.
According to the trade-off, if higher growth is to be achieved, higher levels of inflation have to be tolerated and that low levels of inflation and high growth do not go together. Later, theories have however proven otherwise, a view also held by the RBI.
According to the RBI, while a trade-off may exist at a low level of inflation – some amount of inflation is supportive of growth - beyond a certain threshold, inflation has an adverse affect on growth.
Several empirical studies have proven this to be the case for India.
According to the RBI’s current assessment, the threshold level of WPI-based inflation for India ranges from 4.4 to 5.5 per cent.
The inflation – growth connect is borne out by numbers over the past decade (2003-04 to 2012-13).
The trade-off
If we look at the data on growth as measured by real GDP (GDP adjusted for inflation) and WPI-based inflation, it can be observed that periods of high growth have been associated with relatively low inflation and vice-versa. During 2003-04 to 2007-08, when growth averaged 8.7 per cent, inflation was at 5.5 per cent. The converse was true between 2011 and 2013, whengrowth slowed down to 5.6 per cent and inflation went up to 8.2 per cent. Against this back-drop, the recent uptrend in WPI only adds to the existing pessimism on economic growth.