Inflation-growth track record

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: With the Reserve Bank of India (RBI) recently receiving criticism from all sides for its management of inflation and exchange rates, it is interesting to examine India’s recent inflation-growth track record, and understand the causes behind its good performance.

India always seems to suffer in comparison to China, though it may well do relatively better in the longer run—witness China’s mounting problems with quality control in manufacturing, environmental degradation, and now even inflation. But put aside that popular pairing, and instead look at India relative to a few other large developing countries.

The table shows annual percentage rates for real growth and inflation. In the last seven years, India’s growth and inflation record is considerably better than any of these countries. If one includes the tough years around the Asian financial crisis, then the last dozen years make India’s relative performance look even better. One possible lesson from this comparison is that India has followed better policies during this period. Faster growth might be ascribed to catching up, or ongoing policy reforms, or even the late unleashing of entrepreneurial energies.

But the inflation record has nothing to do with these factors. If we accept that inflation is a monetary phenomenon, then the credit for good performance on this front must go to India’s chief money manager, the RBI. The ostensible puzzle here is that the RBI has not seemed to follow a monetary policy route that might fit with academic orthodoxy.

It is not particularly clear or transparent in its functioning, it employs quite a few quantitative and discretionary (perhaps bordering on ad hoc) policy levers, and it simultaneously tries to manage large external capital flows and the level of the exchange rate, along with domestic credit conditions. Yet, the Indian economy’s inflation performance is quite good, benchmarked against other large developing countries.

On this evidence, one could also credit the RBI with contributing to a strong growth performance, since it has avoided the double-digit inflation rates that have at times plagued the other countries in the table—and empirical evidence across many countries and over time suggests that double-digit inflation hurts growth. A related puzzle pertains specifically to capital account openness.