It is not usual for a central bank to be doing nothing at a time when growth is slipping faster than expected. The first quarter review of the monetary policy by Reserve Bank of India (RBI) on 31 July, as widely expected, was virtually a non-event. And if recent fiscal trends are anything to go by, it is likely to remain this way in the foreseeable future. What will further complicate the making of monetary policy is that prices are now expected to rise faster than expansion in economic activity for the rest of the year, a situation no central bank would like to be in. RBI expects Indian economy to grow at 6.5% in the current fiscal while it expects inflation to be at 7% by March 2013.
The reason for having the worst of both worlds—high inflation and low growth—is well known: the lack of fiscal responsibility on the part of the government. The fiscal deficit in the first quarter of the current fiscal has touched 37% of the full year target, an indication that government will again overshoot its full year target by a mile. If one factors in measures for drought relief; slippages in the subsidies regime; shortfall in revenue due to slowing growth and inability to meet disinvestment targets, fiscal deficit as a percentage of gross domestic product (GDP) could rise beyond the 5.5% mark. Some analysts have even placed it in the 5.7-5.9% of GDP range. If that happens, it will make nonsense of the “fiscal consolidation” efforts announced with much fanfare in the Union budget.
The fiscal balance—or imbalance—has reached a stage where even meaningful course corrections will become painful in the short term before facilitating private investment and growth in the long term. However, any delay in adjustment on the fiscal side, apart from the danger of making monetary policy redundant, will allow investment climate to worsen where growth will continue to sink while prices will remain high, a situation that will hurt everyone and especially the poor. At this stage, India is undergoing a painful course correction—that of shaving off growth. But it is not clear if the government has learnt the right lessons.
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