Last week had one bit of economic news that was a pleasant surprise and one that was neither pleasant nor a surprise.
The good news was that the economy grew at 9% in 2007-08, around 30 basis points higher than what the Central Statistical Organisation had estimated in February. The bad news was that wholesale price-based inflation has broken through the 8% barrier. Given the likelihood of upward revisions to get the final inflation number, India is perilously close to double-digit inflation. And when the government finally decides to stop fiddling and increases the domestic prices of petrol and diesel, inflation could end up at levels not seen since the mid-1990s.
The combination of higher growth and higher inflation should clear the dilemma that policymakers have struggled with over the past few quarters. The vexing question has been whether interest rates should be cut to support sagging growth or if they should be increased to quell growing inflation. The new GDP growth numbers could be taken to mean that growth is not actually sagging. So, the Reserve Bank of India (RBI) should now take its mind off the prospects of a slowdown and go after the inflation demon with a vengeance. The case for a sharp increase in interest rates is now clearer than before.
The problem comes when we get down to the fine print. The economy has grown faster than earlier assumed because farm output has been a positive surprise. That has more to do with the weather than with interest rates. Industrial growth for 2007-08 has been revised downwards, from 8.9% to 8.5%. Manufacturing growth is singularly unimpressive. There has been a gradual deceleration in investments as well.
So,?the should-we-cut-shouldn’t-we-cut dilemma continues. This newspaper continues to believe that we need a few more doses of monetary tightening. Inflation is rising rapidly. The fiscal deficit is widening. The currency is under pressure. The textbook response to these problems is higher interest rates.
But that will result in the inevitable collateral damage — slower industrial growth and, perhaps, a setback to new investments. In short, there are still no easy exits.
Is there now a stronger case for higher interest rates? Write to us at email@example.com