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Indranil Pan: Apr 23 2008, 23:35 IST

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The current economic scenario globally presents a difficult choice for central banks. The world’s super-economies seem to be in a slowdown, with the US economy possibly having tipped into recession already. However, globally, inflation has remained firm, defying economic logic. This makes policy formulation by central banks throughout the world challenging. It is no different for RBI.

The Indian economy has been facing slowing production trends. Consumption demand, especially of interest-sensitive consumer durables, has slowed significantly. Consumer durable goods production witnessed de-growth of 1% in April-February 2008, compared to a 9.7% growth in the same period last year. Even as consumer non-durables production held relatively strong, overall consumer goods production is lower in 11 months of 2007-08 compared to last year.

And demand is likely to weaken further. First, the lagged impact of monetary policy tightening will continue to bite. Along, with higher interest rates, the recent spike in inflation (that too in food items) is capable of reducing consumption expenditure allocated for non-essentials, which is largely discretionary. On the other hand, the booming stock market had led to a sharp increase in consumer perceptions of wealth. With the recent stock market dip, this feel-good factor is likely to be on the wane, thereby reducing consumer confidence and discretionary spending.

It is widely acknowledged that the Indian economy’s unprecedented boom has been a result of soaring domestic demand, even if the big contributing factor was investment demand rather than consumption demand. The current economic cycle, starting from around 2001-02, witnessed a

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