Policy of pusillanimity

The Chief Economic Advisor, Dr Kaushik Basu, has, in a straightforward statement, suggested that if the Reserve Bank continues to raise the price of money, the industrial growth rate will slow down even further. The Reserve Bank of India (RBI), on the other hand, is pretty clear in its mind that inflation control is its main objective. This is not a new divergence. Nor is it a peculiarly Indian one. The conflict between inflation and growth is a very old one. But what is new this time is the clumsiness with which the government, on the one hand, and the RBI on the other, have gone about resolving it. That India was getting into a growth-induced inflation was known to the RBI since at least mid-2007. At that time, the government did not allow it to act. A year later, just before the parliamentary vote on the nuclear bill, when the government was unsure about its prospects and thought that there might be a general election in 2008 itself, it forced the RBI to raise rates steeply. Then, when the danger passed, it reversed its stand even though there was no evidence that inflation was abating.

Since then, partly driven by the need to attract foreign capital inflows to sustain the current account and partly because the Prime Minister had a dream of achieving 10 per cent growth under his watch, the RBI has followed a policy of pusillanimity. The result was a blind embrace of the strategy of baby steps, which the market discounted weeks before it was announced. Inflation roared on and, in the last quarter, the RBI suddenly shifted gears and gave up the baby steps policy, perhaps a year too late. But now that the higher price of money has begun to affect investment, the government, which always wants to have its cake and eat it, is getting jumpy. It knows that the current bout of inflation in India is not originating in the manufacturing sector but in agriculture. The reason for this is staring everyone in the face: whereas the industrial sector has been subject to persistent reform since 1991, including having to face up to import competition, reform in agriculture has remained a gleam in the eyes of some diehards. The political imperative behind this inaction has meant that the entire burden of getting inflation down has fallen on the industrial sector, especially since global commodity prices have also started to come down. The RBI will now have to do the best it can. One could have felt some sympathy for it but not any longer because it failed during 2009 and 2010 to stand up to the government.

The price of this overall faint-heartedness, both in the government and in the RBI, will have to be paid by the economy. Truly has it been said that when elephants fight, it is the grass that gets trampled.

COMMENT NOW