Pessimists, cool it

With inflation below 5 per cent, and therefore in RBI’s comfort range, and growth estimates and projections ranging between excellent to good, it is inevitable that some economic observers would argue the going is too good to be true. These columns have argued that while plenty of problems — including policy stasis — remain, the India story is really true. That is, inflation shouldn’t create panic and severe scepticism about growth sustainability is unfounded. To reprise these arguments is always enjoyable; given recent judgments on overheating, it is also necessary.

The sustainability question is based on low savings/investment ratio, infrastructure constraints and manufacturing’s relative non-performance. On the first and third, data has proved sceptics wrong. Savings/investment rates have sharply increased and manufacturing has done well, fuelled largely by export performance. That leaves infrastructure, where transport connectivity has significantly improved. Power remains a big problem — manufacturing has resorted to in-house solutions. But a binding constraint to 9 per cent growth is hard to find. As for overheating, those arguing for this thesis often confuse sectoral trends (capital market, real estate, skilled labour) of demand outstripping supply with macro-diagnosis of excess demand. Consider the generalisation that the Sensex shooting up is evidence of overheating in stock market. While it is true that there are limited scrips available and privatisation of PSUs would help, the Sensex is hardly representative of the entire Indian stock market. Similarly wage inflation in certain states that attract investments isn’t evidence of general wage inflation, though there are supply-side constraints to skills too, as with real estate and land.

But are there macro evidences of overheating and if there are, is monetary policy the right tool? Whether one should gauge inflation on the basis of WPI, CPI or the GDP deflator is a separate issue. The fact remains that point-to-point WPI is the fastest data we get and for week ending 26th May, this shows inflation of 4.85 per cent. This vindicates this paper’s earlier proposition that point-to-point WPI inflation is a function of last year’s base and as the base increased beyond April, inflation declined. Indeed, barring manufacturing, monetary policy and interest rates will have little impact on inflation and will instead shackle growth. If inflation reduction is the issue, the focus should shift to easing supply-side constraints through reforms (and ending intervention in foreign exchange markets) and even for manufacturing, capacity will come on stream by 2008, rendering knee-jerk reactions unnecessary. Pessimism can be virtue in economic analysis. But some pessimists are overheating a bit. They need to cool down.