Home / Opinion / Online-views /  De-jargoned | Supply side constraint

The present macroeconomic conditions in the country have pushed policymakers in a tight spot; they find themselves caught between slowing growth and high inflation. For example, if the Reserve Bank of India (RBI) eases interest rates, as the industry and the government wants it to, the move will push inflation. However, if RBI maintains higher cost of money to control inflation and anchor inflationary expectations, it will, to some extent, find itself responsible for slowing economic growth.

And that is not the end of matter. It is often argued that high inflation in India is not necessarily a monetary phenomenon and is partly a consequence of supply side constraints. Therefore, a higher interest rate regime will not contain inflation. The argument is also, at times, extended to the point that if RBI maintains higher rates, it will prevent investment and capacity creation due to higher cost of money and supply side constraints will remain.

What are supply side constraints?

In the last review of the monetary policy, while referring to the inflationary situation in the country, D. Subbarao, governor, RBI, said: “On the upside, persistent supply constraints may be aggravated as demand revives, resulting in price pressures."

Supply side constraints, which are now being referred to as a major problem, simply mean that production in the economy is unable to keep pace with rising demand due to a variety of factors such as inadequate infrastructure, lack of credit, availability of labour and availability of technology. For example, it is common to hear from business leaders that though India is a country where labour is abundant, it is difficult to find quality people. Further, availability of fuel is affecting capacity creation in power generation, which will impact sectors that depend on power for production, affecting overall production in the economy.

Factors such as these add up and do not allow the economy to produce at the desired pace. As a consequence, supply to the market place falls short of demand and results in higher inflation. Therefore, it is important that steps are taken at the policy level to remove impediments on the supply side.

The bottom line

On the policy front, there is a danger that if interest rates are cut, it will boost demand in the economy and in the absence of adequate response from the supply side, we may see a bout of even higher inflation. Therefore, as experts argue, in order to control inflation, the government should also take measures to remove hurdles on the supply side.

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