The Economic Survey of 2007-08 is a systematic look into exactly this situation. In common with much of the global economy, Indias policymakers now have to walk a tightrope between stimulating a sputtering economic growth engine and an inflation tinderbox.
Inflation in India has moved up very rapidly from 3.07% in mid-October to 4.35% now. The good news is that the Survey thinks that inflation will remain moderate in 2008. Although economic growth has not collapsed in India, as has been the apprehension in many developed countries in 2008, there is a distinct slowdown in industrial activity, and as a knock-on, in selected service sectors. This is not a surprise, given the harsh application of monetary policy brakes over the past year and a half to cool down the economy. Real interest rates (that is, interest rates adjusted for inflation), while having dropped over the past few months, continue to remain high and are a further disincentive to invest in an uncertain economic environment. At the same time, Indias exposure to the global economy has increased from around half of GDP in 2002 to over 100% as of now. Our estimates indicate that exports add between a fifth and a quarter of Indias manufacturing value added, and that has taken a hit both from a global slowdown and a stronger Rupee. This strength is also starker in comparison with the static or depreciated currencies of many of our export competing neighbours.
The Economic Survey also duly points out that high capital flows, have made the tightrope more slippery. Despite various measures to control the growth of money supply, broad money growth has persistently remained above 22%, and this further constrains the ability of a broad based fiscal stimulus. Without fail, this high money growth will fuel inflation down the line.
So does this mean that we will be in a mild stagflationary period for a while Unfortunately, we think the answer is yes. This is not a calamity in itself; growth will still be very respectable. Its just that our expectations have now become very elevated, and an 8% growth rate is seen as demeaning. The Survey, in almost all sections, lays out the constraints that keep us reined. Even if these are gradually removed, these are long-term measures; in the short run, we will have to live within more modest means. In the immediate future, one palliative, however mild, might be to consider our stance on the Rupee and have it help our goals instead of remain a hurdle.
The author is the vice-president, Business and Economic Research , Axis Bank