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The index of industrial production grew at a paltry 3 per cent this March, the lowest in six years. This should not be brushed off as base effect, or data volatility. The slowdown in industrial growth in recent months is a consequence of macroeconomic policy mismanagement by the government. From the beginning of this year it has been clear that the economy is not overheating any more, and that there might be a slowdown in demand owing to the rising cost of capital and raw materials and a slowdown in the US. The present spell of inflation is due to a rise in global commodity prices and higher domestic liquidity induced by RBI8217;s dollar purchases. RBI tried to fight inflation by raising the cash reserve ratio and interest rates. As this newspaper has pointed out, this strategy was based on an incorrect understanding of the economy. The results are now visible. If RBI now continues to raise the CRR and interest rates, it could easily push India8217;s growth rate to below 5 per cent. The government needs to wake up.

The problem lies elsewhere. The CRR and interest rates hikes were an attempt by RBI to undo the damage caused by its purchases of dollars running to thousands of crores every month. What it did in the process was raise the cost of capital to industry. At the same time, in trying to prevent the rupee8217;s appreciation it put restrictions on external commercial borrowings of firms, again depriving firms of credit. The incorrect assumption here was that fixing the rupee-dollar rate was enough to keep exports growing, and that exports, rather than investment, were driving growth in India. Investment could be taken for granted, while everything possible had to be done to subsidise exporters. This mis-reading led to the present slowdown. Today the country faces high inflation, which is not surprising when on the one hand RBI raised the rupee price of tradables, and on the other kept pumping liquidity into the system. It also faces slow industrial growth.

Investment has been under attack from two fronts. First, RBI has tried to hold back investment by crimping domestic access to funds. Equally, India has shown incompetent policy-making. Instead of appearing an aspiring superpower driven by modern-day economic thinking, India has shown itself to be held back by a central bank and a finance ministry that do not understand macroeconomics 8212; a central bank that advocates capital controls and tries to reverse financial sector reforms, and a government that is willing to ban milk exports or wheat futures. In recent months, every investor has been forced to rethink his confidence in the pace at which India will be able to reform.