Inflation of less than 5.5 per cent can give a fillip to economic growth,a study by the Reserve Bank of India (RBI) has said.
Empirical results show that there exists statistically significant structural break in the relation between growth and inflation at 4.5-5.5 per cent. Thus substantial gains can be achieved if inflation is kept below the threshold,” RBI’s Working Paper said.
The paper,authored by RBI Executive Director Deepak Mohanty and three other officials,found there is a positive impact on growth when inflation is up to 5.5 per cent.
The relationship reverses when WPI inflation is beyond 5.5 per cent and inflation effect on growth turns negative, said the working paper ‘Inflation Threshold in India: An Empirical Investigation’.
The paper comes at a time when the RBI is under pressure due to the sustained inflationary pressure in the economy. Headline inflation stood at a 13-month high of 9.78 per cent in August. RBI has hiked its key policy rates 12 times since March 2010 to tame demand and curb inflation.
Experts have said the repeated rate hikes,which have led to an increase in cost of borrowings,a decline in fresh investments and slowdown in the Indian economy. Economic growth in April-June slowed to 7.7 per cent,the slowest in six quarters. RBI has already revised downwards its growth forecast for the country to 8 per cent in 2011-12,from 8.5 per cent GDP growth in the previous fiscal,and said inflation would act as a dampener. In the paper,the authors tried to find out if inflation in India has to reach some minimum ‘threshold’ before growth effects turn adverse.
“The findings clearly suggest that inflation threshold in the sense of structural break point exists for India and this implies a non-linear relationship between inflation and growth,” it said.
According to the study,the growth-inflation relationship depends on the rate of price rise. “at some low levels,inflation may be positively correlated with growth,but at higher levels inflation is likely to be harmful to growth. In other words,relationship between inflation and output growth is non-linear,” it said. The paper also argues that the concepts of inflation target and inflation threshold are distinct. “Inflation targeting is a construct of monetary policy making in which a central bank announces a ‘target’ and then steers its policy tools towards achieving that target. Inflation threshold is a point of inflexion for the growth-inflation trade-off,” it said.