Word from Mumbai

The Reserve Bank of Indias annual report was released on Thursday by the deputy governor of the RBI,Subir Gokarn,and it made for sobering reading. There were threats to growth,it warned: not just global factors such as weak external demand or high commodity and oil prices,but internal factors such as continual delays in project execution. As has been argued before,the state-caused inability to ramp up supply in the Indian economy means that inflationary pressure,whether or not caused by external factors,persists. The RBI appears to understand this clearly,talking about the high and persistent inflation of the last two years, and adding that that monetary policy,while limited in terms of a first-order effect on the phenomenon,is still relevant in curbing the second-round effects of supply-led inflation.

The RBI expects inflation to go yet higher in the short-term,and that,together with hardening interest rates,could well cause growth in 2011-12 to slow. Meanwhile,the RBI worries,government capital spending has hit a new low even as spending itself has gone up. So deficits might well increase and fiscal space could further tighten,especially if the economy slows more than anticipated,which constrains any attempts at stimulation through fiscal policy. However,the atmospherics with which the RBI surrounds this gloomy news are encouraging: it is necessary for it to create the reputation as a stern inflation-targeting central bank,and thus it is creditable,therefore,that it has signalled its continued focus on inflation even as growth comes under threat and fiscal policy seems cramped.

In particular,the RBI spoke frankly about the danger that a higher inflation level could be expected to be the new normal. Clearly,the RBI does not intend to quickly abandon its hawkish stance on inflation: since March 2010,it has raised its most instrumental policy rate 11 times. The RBI does,however,have stern words for the government,which it indicates is not being sufficiently supportive in its actions. Two years of inflation have laid bare its limitation in arresting inflation in absence of adequate supply response, it says. It is now up to the government to initiate second-wave reforms,the only remaining defence against inflation.