In an election year, it is perhaps unrealistic to expect the Reserve Bank of India (RBI) to push ahead with growth at the cost of inflation management. The signs had already emerged at Davos, where Indias finance minister said that between growth and inflation, it was the latter that concerned the poorand thus the governmentmore than the former. Through most of 2006, the UPA government had been nervous on account of inflation. Obviously, with an election looming not too far beyond the timespan that monetary policy takes effect (with a lag, that is), the risk of rising prices would weigh very heavily on anybodys mind in government. In any case, from a classical monetarist point of view, the central banks priority is to keep inflation expectations in checkwhich, in turn, sets conditions for economic growth. By keeping all its key rates unchanged in its third-quarter review of credit policy, the RBI has made it clear that it would prefer to maintain price stability above everything else. While its GDP growth projection is unchanged at 8.5%, its inflation tolerance band has been reduced to 4-4.5%. Actual inflation, as Dr YV Reddy has pointed out, is above the RBIs threshold level. There have also been other factors. Broad money supply growth, for example, has been consistently above 23%. Onlookers may have been disappointed, but such decisions as which risks are more bearable than others depend on the political context.
Yet, it is interesting that this is perhaps the first time that Mint Street has given such blatant precedence to inflation control over economic growth. Given that the US economy is very nearly in recession, and domestic growth is losing some of its momentum, this will give some observers nightmares of a repeat of the mid-1990s tightening episode. The RBIs own Industrial Outlook Survey expects a fall in industrial activity in this fiscals fourth quarter. The business assessment index for October-December 2007 and expectation index for January-March 2008 have declined by 2.5% and 4.7%, respectively, over the previous quarter. Almost all business confidence indices show recent declines. The credit squeeze has begun to hurt. At 8.5%, Indias GDP growth this year may seem heady. But year-on-year, it is almost a 100 basis points dip. And the 2008-09 rate of growth, most analysts believe, will be lower still.