Column: What kind of inflation, why buy dollars

Written by Bibek Debroy | Updated: Jul 31 2009, 03:49am hrs
One shouldnt be surprised at what RBI has done, or not done. After the first quarter review, this was entirely expected. Most of the first quarter review is about 2008-09. For 2009-10, other than business confidence surveys, RBI collates forecasts of real GDP growth and we have a range of 4.8 to 7.5%. The real outlier here is PMs Economic Advisory Council, which has 7 to 7.5%. If that is excluded, we have a range from 4.8 to 6.9%, the point being that later forecasts are higher than earlier ones by almost 1 percentage point. RBI itself expects 6.5%.

There are several reasons for relative optimismIIP growth has been positive since April and more industry groups show positive growth; infrastructure sectors show higher growth since April; cement production has perked up; service sector indicators are better; large fiscal packages; positive non-food credit growth from June; better corporate performance in Q1; and revival of capital market (including the primary segment) in Q1. RBI doesnt mention the 6th Pay Commission. But there will be that too, spilling over into states and quasi-government. Most will agree with this diagnosis. Q3/Q4 of 2008-09 were the worst and from Q3 of 2009-10, there will be some sort of recovery.

But again, one cannot but agree with RBI that robustness of revival is questionable. On the half-empty glass side, we have delayed monsoon; global recession and its effect on exports; lagged effect of manufacturing decline on services; negative growth in capital goods even after April; bad performance of commercial vehicles; and lacklustre performance of non-oil imports. So, RBI is concerned about how strong or how green these shoots are. Had there not been question marks on these, one gets a sense from the review that RBI would have shot down the shoots.

Worries about inflation have surfacedthe high base effect will peter away; increase in commodity prices (such as oil and even food) in Q1; increase in MSP; delayed monsoon; high prices of sugar and edible oils; high CPI; inflationary expectations; and effects of fiscal stimulus and accommodative monetary policy. At least in this segment, there is no mention of possible monetisation of deficit, high government borrowing and financing of deficit. In a different segment, we have, The financing pattern of GFD as proposed in the Budget reveals that the government

envisages financing almost the entire amount of the deficit during 2009-10 through market borrowings.

For 2008-09, there is a quote that is extremely significant. The trend was known, what is illuminating are the numbers. With the sharp deceleration in the growth of private final consumption expenditure (PFCE) in 2008-09, however, there was a compositional shift in the contribution to growth from private consumption expenditure to government consumption expenditure. In real terms, the contribution of private consumption expenditure to GDP growth, which was 53.8 per cent in 2007-08, declined by nearly half, to 27.0 per cent in 2008-09, while that of government consumption expenditure was as high as 32.5 per cent in 2008-09, as against 8 per cent in 2007-08.

For green shoots to become greener and robust, we need a low interest rate regime. Else, there is no reason to obtain expected investment rate of 36.6%. Interest rates dont depend on RBIs policy rates alone. There are factors like interest rates on small savings, cross-subsidisation of priority sector lending and excessive gap between deposit and lending rates. However, upward pressure on RBIs policy rates also seems certain, since RBI is concerned about inflation.

There are issues like government borrowing, intervention in forex markets and non-relevance of monetary policy for the kinds of inflation RBI has mentioned. But thats neither here nor there. Those arguments were also valid when RBI switched to a high interest rate regime through hardening of policy rates. The government paid scant attention then and it will pay scant attention now.

So, forget any softening of policy rates, as some people had expected. One should be thankful that hardening has not already happened and policy rates and CRR have been left untouched. Had it not been for uncertainty about growth revival, hardening would have occurred now. At best, it has been postponed for some time. Not a very profound policy response But is it less profound than the following gem

Indias structural growth impulses continue to remain strong, given the high domestic saving rate, sound financial system, and growth supportive macroeconomic policy environment.

Domestic deceleration in demand and persistent uncertainty in the global conditions, however, operate as the major drag on a faster recovery. Early indications for India suggest that the revival impulses need to strengthen further to boost the consumer and investor confidence, which could then set off a positive feedback loop to lift the growth momentum over time.

The author is a noted economist