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National Story
 
ECONOMY: INDUSTRIAL SLOWDOWN
Inflation & growth: Can the twain meet?
Persistent Hikes in key policy rates have failed to slay the monster of inflation. Instead, it has inflicted collateral damage: slowdown in India’s manufacturing growth. B&E was the first to identify that India was slipping into a definite slowdown (cover story; August 4, 2011). What can policymakers do to bring down prices without hurting growth?
Issue Date - 27/10/2011
 
It is the season of bad news. News of scams and scandals, protests and labour strikes, a wobbling Sensex, soaring food prices and policy paralysis in the government have been hitting the headlines with metronomic frequency. The depressing state of affairs in the global economy and the spreading debt crisis in Europe are an added aggravation. In the past, India weathered the global financial crisis with aplomb thanks to the timely intervention from the Centre, which understood the gravity of the situation and promptly reacted by releasing three stimulus packages in quick succession amounting to Rs.1.86 trillion during 2008-09. But after a brief sunshine, the storm clouds are back on the horizon.

The worst piece of news to have hit the Indian economy in recent days is that the country’s factory output has slowed to its lowest pace in the past 30 months. According to figures released in September this year, the manufacturing PMI, or Purchasing Managers’ Index, for India, slid more than two points to 50.4. This a shade above the 50 mark, which separates contraction of manufacturing activity from expansion.The September survey finding – based on data from more than 500 manufacturing firms – was the lowest since March 2009, when the Index had slipped below 50 owing to the global slowdown.

That India was inching towards economic slowdown was first indicated by numbers thrown by the Index of Industrial Production in July. The IIP figures showed factory output growth dipping to a 21-month low at 3.3% in July 2011 as compared to 9.9% in the corresponding period a year ago. To add to the cup of misery, the Wholesale Price Index based inflation stood at 9.22% in July, much above the 5.5% mark, which the RBI thinks to be the comfort zone. Such persistently high inflation above 9% has not been witnessed anywhere else in South Asia/South East Asia or even Latin America in recent times.

Both the PMI Survey and IIP raise certain questions and fears about the future course and direction of the Indian economy. As a result, fresh doubts are being voiced about the ability of the economy to sustain its present growth momentum. HSBC chief economist for India & Asean Leif Eskesen thinks that Indian manufacturing growth is clearly slowing in response to the tighter monetary policy, uncertainty created by high inflation and weak global economic environment. Economists of different hues concur that as the effects of a dozen interest rate hikes by the RBI over the past 18 months continue to reverberate across the economy and so long as global economic conditions don’t improve, growth in India’s manufacturing sector will remain subdued in the foreseeable future.

 
The recent economic indicators have left policymakers at the highest level disappointed too. According to C. Rangarajan, Chairman of the Prime Minister’s Economic Advisory Council (PMEAC), the Council may revisit its earlier growth projections for the country. The Council had projected industrial growth at 7.1% for the current fiscal. Despite the recent setback, Rangarajan is still hopeful of higher industrial growth. “At the moment, perhaps, the numbers are not encouraging…But if industrial production improves in the second-half of this fiscal, then the overall growth rate may be higher.” Another top policy maker, Planning Commission Deputy Chairman Montek Singh Ahluwalia has stressed the need for a pick-up in investments to spur manufacturing growth.

But despite the differences in growth projections, people across the board are blaming RBI Governor D. Subbarao for putting manufacturing growth in a sling. And many fear that the worst is yet to come. Ramu Deora, Chief of Federation of Indian Exports Organisation, voices his concern about RBI going for yet another hike of 25 basis points later this month, which would take repo rate to 8.5%. Industry chieftains fear that any further rise would act as the proverbial last straw to break the industry’s back as cost of funds would become too prohibitive for borrowing.

Clearly, RBI’s monetary tightening is not helping growth. But the central bank feels that taming inflation is a bigger priority even if some growth has to be sacrificed in the process. Such a stance, of course, leaves growth apologists and industry advocates red in the face. One way to make the trade-off between growth and inflation more amenable is to widen the tax net. Currently, only 3% of population comes under the tax net and bringing more people under its ambit could be a good way of limiting the flow of a large amount of unaccountable money “floating” in the economic system, which is the cause of inflation. Unfortunately, RBI’s interest hikes are only hitting at genuine growth/manufacturing. The situation is exacerbated by the fact that another global recession looms large.

Have the RBI’s efforts to hike key policy rates been able to contain inflation? Not really. Monetary policy has proved ineffective in the face of volatile global commodity prices, mostly of food and fuel. Ahead of the quarterly review of monetary policy on October 25, leading bankers at a recent banking conclave in Mumbai — which included Pratip Chaudhuri, Chairman of State Bank of India, the country’s largest lender, M. D. Mallya, Chairman & MD, Baroda Bank, Chanda Kochhar, MD & CEO, ICICI Bank, Shikha Sharma, MD & CEO, Axis Bank and other top banking executives – said they have had enough policy rates hikes and voiced concern about signs of a slowdown becoming increasingly visible.

But other than hoping for the RBI to press the pause button on its monetary tightening measures, what else can be done to ward off the decline in manufacturing growth? The general consensus is that policy makers need to evolve a coordinated policy framework and help to create a climate of investor confidence to arrest inflation and contain its fallout on industrial production. But to expect that RBI’s interest rate hikes alone will neutralise the inflation dragon would be just too naïve.

K. S. Narayanan           

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