Instead of relying on monetary policy to beat back inflation, the government should push long-pending reforms to ease supply constraints, such as allowing FDI in multi-brand retail and paving the way for GST.
The recent 25 basis point hike in interest rates by the RBI, about which there was a sense of inevitability, has further strengthened the perception that India is faced with some difficult macroeconomic options in the coming months. Inflation does not seem to be headed downward, despite the RBI having raised interest rates 10 times by 275 basis points during the last one year. In May 2011, the WPI, which the RBI apparently continues to use as the basis for its policy decisions, stood at 9.1 per cent year-on-year (all figures on inflation refer to the year-on-year) which was higher than the 8.6 per cent in April 2011. Core inflation (minus food and fuel) was also higher in May, having risen to 8.6 per cent, as compared with 8 per cent in the previous month. Global oil prices are still not showing any significant downward trend and global commodity prices, including food prices, also remain firm and volatile. Domestically, signs of any relief from a strong supply-side response are also not yet visible. The news on the monsoon front is not too good, with the Meteorological Department revising its monsoon forecast downwards. Capacity expansion has nearly stalled, with growth in gross fixed capital formation (investments) having declined from 17.4 per cent in the first quarter of 2010-11 to a mere 0.4 per cent in the fourth quarter of 2010-11. Resources locked up in stalled projects are currently three times the level in 2007-08. Thus, it does seem that the RBI, committed to bringing down the inflation to within its comfort zone of between 5-6 per cent, and egged on this direction by the Prime Minister's Economic Advisory Committee, will continue raising rates for the next few months. This could well imply further reduction in growth forecasts which are now already firmly below the 8 per cent level. Is it not time therefore to lower expectations and focus more on the reforms that are required to put growth back on the 9-10 per cent trajectory that seemed to be well within our grasp not so long ago? The purists will argue that with growth still above 7 per cent, this is the time to redress macroeconomic imbalances and not be distracted by short-term weakening of the growth momentum. There is, of course, merit in this argument. But the catch is in the recipe to be used for restoring the macro-balance. If we continue to rely almost exclusively on monetary policy for achieving this balance, I am afraid we are destined to not only fail in our objective but also end up causing serious damage to medium-term growth prospects and inflict considerable pain on the people. Over-reliance on monetary policy would imply pushing up rates to squeeze out inflationary expectations even if it implies a major slowdown in GDP growth, as was experienced in the latter half of the nineties. Given the higher aspiration levels now, this could generate serious social stress and further vitiate the political atmosphere. This is not the advisable way forward. Instead, the government will hopefully find the will and the political acumen to push forward with the reform agenda that will remove some of the supply-side constraints and improve the investment climate. There are several steps that the government could take that do not require any legislative action. These include the finalisation of the manufacturing policy; announcing a policy on FDI in multi-brand retail; the delisting of perishables from the APMC Act; permitting the actual dismantling of the administered oil price mechanism; and bringing down fertiliser subsidies. These measures should be announced as soon as possible as any further delay could make these decisions hostage to the next round of elections — polls in UP are less than 10 months away. The news that the Ministry of Fertilisers is opposed to the recommendations of the Saumitra Choudhary committee on hiking urea prices does not augur well and, if true, the Ministry should be directed to let the greater national welfare prevail over sectoral considerations. A serious effort is, however, required to ensure that even the major reforms currently stalled due to lack of sufficient political support are pushed forward. These include the GST, which has the potential to raise growth rates by a couple of percentage points on its own; and the financial sector and education sector reforms, for which Bills are now pending in Parliament. These reforms are critical for achieving the adequate supply-side response. Education sector reforms are specially critical as these are key to accelerating skill formation and expanding training and education capacities in the economy. Without such capacity expansion and improvement in the regulatory framework in the education sector, the demographic advantage that the country possesses will be lost. The implementation of these reforms, however, requires broader political consensus that can only happen if political parties set aside opportunistic considerations in deference to national welfare. I am not sure if the gravity of the economic situation and the need to push forward the reform agenda is still sufficiently clear to our leaders across the political spectrum. I hope it is. I am afraid, India's economic story may not be able to bear the cost of another wasted Parliamentary session and the paralysis in governance.
(The author is Secretary-General, FICCI)
