A Time to Choose: DNA: 8th September 2008

The new RBI governor has to decide between aiding growth and controlling inflation
With a new governor taking over the Reserve Bank of India (RBI), it is a good time to evaluate the prospects for the Indian economy. Four factors must be kept in mind. The first is that there are signs of industry slowing down and inflation is still high.
The second is that we are not alone in this conundrum, as slower growth and inflation are an all-pervasive phenomena and central banks everywhere in the world are trying to resolve these twin problems. The third is that there are some indications of world prices, especially of oil, cooling down.
Lastly, the change of guard at the RBI is germane to this issue because future policy will be guided by a new wave of thinking on Mint Street.
At this moment, the prospects for growth look bleaker than they were last year. The question in one’s mind is whether we will be over 8 per cent this year or fall somewhere below. The majority consensus is that 8 per cent will be difficult. The RBI had also scaled down the number from 8-8.5 per cent in April to 8 per cent in July.
The PM’s Economic Advisory Council (the new RBI governor was a part of this council) had brought it down to 7.7 per cent while others are pitching for 7.5 per cent with a bit of luck. The numbers matter not just for the psychological reasons, as 8 per cent sounds good while anything lower gives the impression that we have lost out somewhere.
The important thing is that even 0.1 per cent difference means that real income of around Rs3,100 crore is lost (our GDP in real terms is Rs31,00,000 cr), and hence the difference between the RBI and the PMO’s projections could mean close to Rs10,000 crore in income.
Broadly speaking, the economic performance will be driven by the kharif harvest and RBI action. The agri outcome will determine the amount of money that will be spent by the people. People in rural India are dependent on the harvest and a good one means that they can spend easily on other industrial goods. Therefore, the months of October-November are critical.
City folk, too, plan their expenses, especially on white goods and automobiles, at this time. In fact, housing projects invariably take off during Dussehra and keys are handed over for new flats at the time of Diwali. It is not surprising that this is the time when companies as well as retailers offer the highest discounts.
These discounts rise during times of an economic slowdown and hence this year we could expect more of such competitive sales for refrigerators, TV sets, washing machines, and the like. The season ends when the New Year comes, which is spending time again for all people as those who missed the bus earlier catch up with their purchases.
This is where the RBI can make a difference, as interest rates will guide spending patterns. The new RBI governor will have to toss the coin for either favouring growth or paying attention to inflation. Higher interest rates could put a spoke in the wheel as consumption decisions are postponed for a while, especially in the mortgage sphere.
At the same time, inflation today is more or else accepted as a double digit phenomenon. No one really expects inflation to come down to 5 per cent this year. In fact, curiously, the comparable numbers for the CPI (consumer price index) inflation are in the region of 7.5-8.5 per cent and hence project a more tolerable picture today. But to expect that inflation will come down to a single digit would be a bit too optimistic.
With all of us getting reconciled to a double digit inflation rate, it may be prudent for the RBI governor to persevere with the growth objective and aim for above 8 per cent growth rate which will mean a more liberal approach to interest rates. The new governor was part of the 7.7 per cent estimate and is now a part of the 8 per cent estimate for GDP.
Even while trying to reconcile the two numbers, he would have to take a judicious call on interest rates. Inflation, as mentioned earlier, is unlikely to come down drastically, and the global conditions probably signal that the worst may be over as of now.
If the RBI is happy with a 7.7 per cent number, then it could continue tightening the monetary side, but if it pitches for higher growth, then rates may have to be reduced to spur demand from both consumption and investment. For this, they also run the risk of spurring inflation, though frankly, once the rate is over 10 per cent, 12 or 13 may not really matter. But with a general election looming in the background, inflation management may be more important. After all, the common man does not understand growth or GDP for that matter. But he knows what inflation is, and that matters the most.