It’s worrying to see (annual) GDP (gross domestic product) growth below six per cent. And, equally worrying to see retail core inflation remain close to 10 per cent. More, the real worry is that these two phenomena can exist simultaneously! If growth is so far below trend for the past seven months, why is core retail inflation so elevated? Why is core manufacturing inflation still at the five per cent mark?
Unfortunately, the only way to square the circle is to accept the fact that India’s potential rate of growth has fallen quite sharply over recent years. Of course, demand has slowed. But so has private capacity creation over the past few years — manifested in a corporate investment that is a whopping five percentage points of GDP lower than in 2008 . So, despite the economy growing below six per cent, there still isn’t enough slack in the system to choke off inflationary pressures.
So, what ails investment? The Reserve Bank needs to be commended for explicitly pointing out it’s not interest rates! Real rates today are still lower than in the mid-2000s, when investment was booming. Instead, the proportion of projects on the ground that are stalled or abandoned have surged over the past two years. And, began to do so even before RBI’s rate increases of 2011. The constraints are well known — land, environmental clearances, coal availability, regulatory and policy uncertainty. Cutting rates is unlikely to resolve any of these issues. Instead, it will likely stimulate consumption, thereby putting further pressure on inflation and inflationary expectations.
At the June review, the central bank threw down the gauntlet. Retail inflation in double digits and wholesale inflation at over seven per cent was unacceptably high. Signs of credible fiscal consolidation and the easing of supply constraints had to be prerequisites to any further easing. Markets were disappointed but respected RBI’s resolve.
Now, the central bank must stay consistent. If anything, the outlook for inflation is less benign than in June. The monsoon continues to play truant and food inflation — and, therefore, rural wage pressures through the formal indexation of NREGS wages — is expected to resurge. Measured in rupee terms, India’s crude oil basket is five per cent higher and the global commodities index (CRY) is more than 10 per cent higher than at the time of the June review.
So far, even one-off increases in domestic energy prices have not been witnessed, let alone a more credible plan to rein in subsidies and the fiscal deficit. And, significant breakthroughs to ease key infrastructure bottlenecks are still awaited.
In cricket, they say you are judged as much by the deliveries you let go as you are by the deliveries you play at. In that spirit, RBI needs to sit this one out. That will add to the pressure on the government to act first. Anything else will be tantamount to putting the cart before the horse.
The author is India Economist, JPMorgan
