India’s Central Bank, the Reserve Bank of India released its Economic Policy for 2010-11, explaining India’s high inflation rates, liquidity lapse, rise in interest rates and growth projections. The economic policy, released roughly a month prior to the Central Government’s annual budget is usually a precursor of things to come and an indication of changes New Delhi might tweak for the following financial year April 2011-March 2012.
During the speech made by RBI governor Dr. D. Subbarao, the see-saw between inflation and growth emerged as a dominant factor. While bank interest rates were increased for a seventh time this year, the repo rate by 175 bps, the reverse repo rate by 225 bps and the CRR by 100 bps, growth also increased with a baseline projection of 8.5 percent growth in GDP for 2010-11.
As for the rising tide of inflation, the RBI said that from August – November 2010, inflation remained within the projected trajectory of the RBI, after which it moved up from 7.4 percent in November 2010 to 8.4 percent in December 2010, due mainly to sharp demand led price increase of vegetables, mineral oils and minerals. Dr. Subbarao further said, that while the current spike in food prices is expected to be transitory, inflation stemming from structural demand-supply mismatches in several non-cereal food items such as pulses, oilseeds, eggs, fish, meat and milk is likely to persist till the supply response kicks in. Non-food manufacturing inflation also remains above its medium-term trend of 4 percent. As a result, the RBI has raised the baseline projection of WPI inflation for March 2011 from 5.5 percent to 7percent
Going forward, the inflation outlook is expected to be shaped by three factors: (i) on how the food price situation, both domestic and global, evolves; (ii) how global commodity prices behave; and (iii) the extent to which demand side pressures may manifest.
Combating inflation and fueling growth, money supply in the Indian economy has also been controlled. The growth in money supply (M3) this year has been forecast by RBI at 17 percent, while nominal gross domestic product (GDP) growth is likely to be around 17 percent (8.5 percent growth + 8.5 percent average inflation). In other words, if RBI’s forecast of money supply growth is correct then M3 growth is just sufficient this year to take care of the increase in nominal GDP and there’s no excess liquidity.
The balance therefore between inflation and growth right now is akin to walking a tight rope. Err on the side of growth and the country could face combined risks from inflation and the current account deficit, creating economic instability and deterring consumers and investors from decisions affecting growth of the economy. This in turn could lead to slower growth, turning off the foreign institutional investor tap, leading to lower stock prices, affecting tax collections and thus affecting the fiscal deficit, which again could lead to higher inflation. Err on the side of inflation, and similar risks are exposed, investors will lay off, political and economic instability ultimately leading to lower growth. What will be interesting to watch is how the Manmohan Singh led government, will bail the Indian economy out of a lose-lose situation at a time when corporate India is shining.