Home stretch

November 2006’s industrial production figures, released over the weekend, was cheerfully greeted. October 2006’s figures weren’t good; the latest industrial year-on-year growth rate of 14.4 per cent more than made up for the earlier gloom. But the really interesting implication of recent production date is found only after disaggregation. It is pretty clear that investment is growing more than consumption — growth rates for capital goods and intermediate goods are above the industry growth rate, while those for consumer durables and non-durables are below it. Over the last six months, the RBI has been practising moderate but definite contraction. Therefore this investment-consumption divide has crucial monetary policy implications.

Indians’ decisions to buy homes has been one of the crucial drivers of spending in recent years. There is evidence that home loans are growing at a considerably more modest rate — this ties in with slower growth in the consumption sector. To argue for, as some conservative monetarists do, a slowdown in spending while investment activity carries on in the face of restrictive monetary policy is to ignore two things. First, that a huge majority of home loan takers in India are end-users, not speculative investors. Therefore, concerns about speculation should be less at the macro level. Second, the housing sector has big economic linkages. That is, a slowdown in the housing sector doesn’t just mean reduced spending, it also means lower activity in all kinds of economic sectors. At stake therefore will be some of the most important determinants of economic dynamism.

This means that no one can take a view that since inflation is slightly above its preferred 5.5 per cent ceiling, and since consumption is responding to interest rates, contractions in this manner are desirable. Slower growth in consumption may mean large second round effects on many production sectors via housing sector linkages. Of course, it is not possible, no matter how brilliant the central banker, to arrive at an ideal schedule in this scenario. The important thing to remember is that it is possible for restrictive monetary policy to over-correct and indications of how that might happen are already with us. That means the central bank should start thinking about a looser monetary policy, not right now perhaps, but not too far in the future either.