No policy should upset the growth rhythm

Written by DS Rawat | Updated: Apr 29 2008, 01:52am hrs
The second-fastest growing Indian economy could feel the approaching slowdown as developed financial markets reported big time crises, a high borrowing cost pinched the domestic demand and the export-oriented sector started filing losses. At the same, time the global commodity prices shot up owing to a supply shortage and oil prices rose steeply, invoking the fear of inflation beyond tolerable limits. In such a situation, the role of the central bank has become rather dilemmatic to strike a balance between inflation and growth.

The rising inflation has been a major concern. With the rising prices of oil and non-oil commodities, including food, the WPI has shot up to an unacceptably high level. The price level has increased to a three-year high at 7.41% after settling at 7.14% for the week ended April 5, 2008.

While the global grain shortage and a sharp increase in oil prices have driven a majority of the world economies into the price spiral, India remains highly inflation-sensitive owing to less purchasing power and a huge proportion of the population falling in the lower income bracket. Therefore, the central monetary institution shall focus on growth to uplift the millions from a state of poverty.

The robust growth momentum of the economy has begun to come under pressure, with inflation and high interest rates impacting major industrial sectors and dampening consumer demand. The GDP grew at a moderated pace of 8.7% in the previous fiscal compared with the 9.6% achieved in FY07. The impact of rising prices, the slowdown in the US economy, and the appreciation of the rupee is visible in slowing the GDP growth.

Even with a declining GDP growth, the savings and investments rate has remained strong until now. The gross savings rate as a proportion to the GDP has increased from 23.5% in 2002-03 to 34.8% in 2006-07. The investment rate has gone up from 22.8% in 2006-07 to 35.9% in 2006-07. But, the recent hike in the cash reserve ratio by 50 bpsfrom 7.5% to 8%can impact investments, with companies postponing their capex plans. This can adversely affect the employment situation, further decelerating growth. For savings and investments to grow further, it is crucial to facilitate a non-inflationary growth.

Tightening the money supply to curb inflation is a standard textbook measure followed by central banks. A reduced money supply level dampens the demand for goods and services and, thereby, controls the price rise. However, the present inflationary pressure is supply-driven rather than demand-induced. The price rise is primarily driven by the global supply side factors that the monetary policy may find difficult to influence directly.

The policies need to be designed in a flexible way to augment investments, which would help in increasing supply. It is necessary to provide a major push to investments so as to lay a robust base for growth, especially at a time when the global economy is slowing down amid fears of a US recession and rising commodity prices.

Inflation-control through CRR hikes to suppress demand is a temporary phenomenon, which may yield results only in the short-run. With high inflation rates, a further tightening of the monetary policy could have adverse effects on growth.

To continue the growth momentum, the Reserve Bank of India needs to devise sector-specific policies to achieve the twin objectives of inflation control and robust growth. The sectors that show signs of resilience may be allocated differentially high interest rates or regulatory caps on other sources of raising funds. A sweeping hike in interest rates only worsens the price situation as the capacity-generation process gets impeded.

Automobile, housing and construction are interest rate-sensitive sectors. A further hike in the interest rates would hamper growth, which may have a direct impact on the output and employment in these sectors. The central bank should not neglect the significance of sustaining demand and growth in these sectors as they provide employment to a large, migrant rural workforce.

The outlook of the RBI in a giant economy like India should be flexible, forward-looking and holistic in nature. Inflation control remains an indispensable nature of its policy purview. Yet, the RBI needs to ensure that its policies do not hurt the growth rhythm. Efficient systems and procedures in the credit delivery system will accelerate productivity, employment and growth.

The writer is secretary-general, Assocham