It146;s monetary

There has been a rapid change in sentiment about the Indian economy in recent weeks. A few months ago, nothing could go wrong with the India story. Growth was high, inflation was low, foreign capital was flowing into India, the rupee was strong. Suddenly, everything has turned around. Industrial growth is down to single digits. Inflation is up to double digits. Interest rates are rising. The stock markets have seen a sharp fall. The rupee has weakened and foreign investors have turned away from India. How was the amazing story of Indian growth reversed? It8217;s true, the global oil and commodity price shock was one of the triggers. But it is not the full explanation. India has been hit especially hard because of the lack of a modern macroeconomic policy framework.

Even as the economy has rapidly opened up, policy-making has remained firmly entrenched in a closed economy mindset. While the fiscal correction has been affected by the oil shock, and the huge food, fertiliser and fuel subsidies are a disgrace, the less-known story is about how monetary policy has been mismanaged all through the four years of this government. In terms of the domestic policy factors, it is the conduct of monetary policy that is the most important element in how macroeconomic policy was mismanaged. The inflation shock to the economy is one of the main factors responsible for the change in sentiment as well as for the slowdown through higher interest rates that it is now inducing as a policy response. The biggest policy mistake of the UPA government was to run loose monetary policy for four years.

The results of this policy have come to haunt it at a time when this government can least afford it. The lack of courage to break away from the past framework of an Indian economy shut off from the world, the belief that controls and licences would continue to work, and the inability to comprehend that policies that have worked well in the past will not work in an open market economy have led to the biggest policy mistakes being made by this government. RBI has failed to face up to India as an open economy, and denied that the country has to make a choice between a strong dollar and the risk of high inflation. The government ignored all signs of macroeconomic mismanagement. The continued use of obsolete macroeconomics has led to the biggest failure of the UPA.