The industrial output, a leading indicator for growth in the economy, for the month of August is lower than expected mainly because of the shrinkage in the index of capital goods and consumer durables, reflecting mollified demand illustrated by lower sales of cars. The retail inflation is the lowest since January 2012 because of drop in food prices and muted consumer demand. In a related development, the finance ministry has been considering to assign an inflation target to Reserve Bank of India (RBI) in an effort to modernise monetary policy. In fact, the new government assumed office in the midst of an important debate on what should be the correct monetary policy framework for India. The debate basically hovers around the philosophy of adopting inflation targeting in India and finds its origin in the Committee on Financial Sector Reforms (CFSR) set up by the Planning Commission in August 2007. The findings of the CFSR resonated, after 6 years and great financial recession, in January 2014, in RBI?s Expert Committee on Monetary Policy Framework (ECMPF). In the very first budget of the new government, the finance minister doused the flames of the raging debate by announcing the need to modernise monetary policy.
The monetary policy framework, successfully followed in India and hailed by the world during the recession, is the multiple indicator approach (MIP). It may be mentioned that India was a pioneer in crafting the MIP after the South East Asian Crisis (SEAC) in 1997-98 and constantly monitored various factors before undertaking any monetary policy decision. These variables, besides inflation, include indicators pertaining to external, financial, banking and real sector. Thus, monetary policy, under the MIP, had a human face and was not mechanically tied to a single numerical value. MIP involves lots of hard work as RBI had always to be carefully watching various parameters to steer the economy away from shallow waters as well as icebergs. Consequently, three successive governors were able to insulate the economy from SEAC and the recession, while avoiding inflationary pressures. In contrast, inflation-targeting placing blinkers on the monetary policy, made many central bankers complacent during great moderation, and was considered responsible, even if partially, for the recession, as central bankers were mainly focused and responsible only for inflation, absolved of other objectives of monetary policy. It probably is for this very reason that none of the countries have adopted inflation-targeting after 2008, except Japan, as documented in ECMPF.
The key objective of monetary policy is price and financial stability, keeping in view growth and employment in the country. The country is in the grip of the ?Make in India? euphoria and, despite the feel-good factor because of the dynamic policies of the new government, stubborn industrial growth, despite the rise in election-related expenditure and onset of festival season, continues to be a reluctant partner in India?s growth story, refusing to budge from its groove of low growth. Consequently, the employment and economic situations continue to be critical.
India is a large economy and is poised to be a super-power within the next decade, given its demographic dividend, untapped rural markets, and pro-market policies of the new government and other reasons. In traditional economic theory, there is a trade-off in employment and inflation. In sharp contrast to the general contention that such trade-off does not exist in India, Ravendra Dholakia of IIM-Ahmedabad, in a well-documented recent research, demonstrates that such a trade-off does exist in India. Therefore, in a young demographic country, the key aspiration of every family, more so after the hyped expectations in recent times, is employment for the willing individual. And as employment brings in responsibility, obligation and sense of belonging in any employee, it will be helpful in progressively constructing industrial India. The new government is encouraging industry, especially the housing sector, and MSMEs, but generating meaningful employment and achieving production would follow a gestation lag. The monetary policy can supplement and hasten process by favourably adjusting the interest rates leading to higher investment.
The uncertainty associated with the new monetary policy framework could also impact expectations and recovery of the industrial sector. Though inflation-targeting sounds modern, it may not be suitable for a ready transplant in India given the current state of the economy as well as the status of price indices. Therefore, the period of transition from MIP to a new framework, if any, would need to be carefully managed through wide-spread consultations, healthy debate, informed public opinion and appropriate sequencing. In the current situation, to kick start industrial growth in the economy, the policy makers could consider the following steps. First, to arrive at an appropriate monetary policy framework, a high powered committee be constituted to consider ushering in a paradigm shift in monetary policy framework, after evaluating the existing regime. Second, the construction of existing consumer price index, which has nearly fifty percent weightage of food products in a consumer basket, needs to be re-examined and perhaps even, corrected. Finally, given that inflation has been subdued and is getting widely recognised as a supply-side phenomenon, and in view of industrial growth being sticky at low level, RBI, can consider a conditional experiment by lowering interest rates this festive season and contribute to positive expectations.
The author is RBI Chair Professor of Economics, IIM-Bangalore
