Opinion Cut in context

RBI Governor Raghuram Rajan must believe that India is already on the way to economic recovery and needs only a gentle push from the central bank. This would explain his commitment to lowering policy rates by just another 0.5-0.75 per cent by the end of this year if inflation remains subdued. Rajan is not alone in his belief. The World Bank has pronounced the Indian economy on its way to recovery, the UN has predicted a growth rate of 6.4 per cent in 2015-16 and higher growth rates than China’s in coming years. Chief Economic Advisor Arvind Subramanian has declared that the economy has made a “remarkable turnaround”.

But there is a woeful lack of data to support this conclusion. The only hard evidence — a 3.8 per cent rise in industrial production in November — blurs under closer scrutiny. For November was preceded by October, when the IIP had fallen by 4.2 per cent. So industrial output actually contracted by 0.2 per cent in these 61 days. Even the 2.2 per cent growth officially recorded in April-November is partly a statistical illusion because of the “low base effect” of a 1.2 per cent industrial contraction in the first quarter of 2013-14.

The inescapable fact is that eight months after the Modi government came to power, industry remains stagnant. The GDP growth figures have been propped up mainly by service sector data, notorious for its unreliability. Not only has manufacturing remained static, but consumer durables, normally the fastest growing segment, have also contracted by 15.9 per cent (over a 12.6 per cent decline in the previous year) and capital goods have shown a paltry increase of 4.8 per cent in the past seven months, after having declined steadily over the previous two years.

Most of the current optimism rests on one slim statistical pillar: the purchasing managers’ index, which has gone up from 51 in early October to 54.5 in early January (less than 50 indicates industrial contraction). But the PMI is essentially an index of expectations and has often been wrong. It is likely to prove more reliable now because the rise seems to be based on an increase in orders. But neither Modi’s assurances nor Rajan’s anti-inflationary policies have had anything to do with the rise in orders. The most important causes are the Rs 12 per litre decline in gasoline prices and Rs 6 per litre fall in diesel prices. This has put approximately Rs 50,000 crore back in people’s pockets. That is the spending filling up order books now. So long as Rajan and almost everyone in government persist in believing that it is the RBI’s draconian “inflation targeting” through high interest rates that has tamed inflation, we run the danger of being pushed back into recession by, say, Iran and Syria joining the war on the Islamic State or Ukraine sliding into open civil war — events that have nothing to do with our economy.

From January 2007, when the RBI first began to raise interest rates to prevent what it assumed was an “overheating” of demand, India’s economic woes have been rooted in a fundamental misunderstanding of the nature of the inflation that began in the summer of 2006 and resurfaced, after a short hiatus caused by the onset of global recession, in March 2010. Much of this inflation was caused, not by an excess of money chasing a dearth of goods, but by domestic supply shortages stemming from poor or untimely rains, power and transport shortages, administered price hikes and, internationally, growing shortages of key raw materials, notably oil. None of these factors could have been tackled by increasing interest rates to reduce money supply.

The RBI’s policy only succeeded in creating stagflation. Rajan came to the RBI when these mistaken policies had created a foreign exchange crisis, and handled it admirably. But once that was over, he too adopted the same failed policy of curbing domestic demand to ease globally induced shortages of supply.

The end of China’s commodity import scramble in 2011 and the economic slowdown that followed, a second dip in the European recession and a fracking boom in the US that has sharply reduced its imports of oil have brought global commodity prices tumbling down. Meanwhile, some exceptionally well thought out policies of the Modi government have prevented shortages of cereals and vegetables, stabilised agricultural prices despite a bad monsoon. These are the factors that have brought inflation to an abrupt halt. The moral of the story is that Rajan must not raise interest rates at every upward blip in CPI inflation.

Jha is a senior journalist and author

express@expressindia.com