In its latest review of the Indian economy, the Prime Minister’s economic advisory council (EAC) has expressed serious concerns about the deficit on the current account—which this fiscal year is likely to be of the order of 3.6% of gross domestic product (GDP)—significantly more than the crisis year of 1991. EAC would like the deficit to be below 2.5%. Surely, this will require a far better managed exchange rate and moving away from the floating rate regime we seem to have adopted during the last few years.


The report also blames inflation for falling domestic investment in recent years and for growth in consumption. It hopes that “with a return of price stability…it is possible to visualize an improvement in the investment rate", and that “price stability will also normalize consumption demand". One has reservations about the arguments as advanced. If consumption has gone up because the consumer is preponing purchases, the same logic would suggest that inflation may well expedite investments rather than delay them. Is it not more likely that consumption has gone up and savings have gone down because of continued appreciation of currency in real terms until recently? It is well accepted by now that an undervalued currency increases savings while an overvalued one has the opposite effect.

But this apart, whether we could see price stability in 2012-13 is debatable. The recommendations/suggestions in the report to reduce the fiscal deficit include “adjustments to the selling prices of refined petroleum products", cut in the subsidy bill which “reduces the resources…available for development expenditure", “the electricity tariffs…overdue for resetting", etc). Again, the long-postponed upward revision of railway fares may well become unavoidable this year. All these would surely increase prices and, therefore, inflation?

Globally, oil prices are shooting up by the day given the possibility of an attack on Iran, and these too would add to inflation pressures. And, in the current conditions, it would be risky to look at the exchange rate as an anti-inflationary tool to limit the domestic cost of imported crude, given the already huge deficit on the current account and the poor quality of our reserves. (Perhaps, it is inadvisable even otherwise.)

Coming back to inflation and growth, our central bank seems to have arrived at a conclusion that Wholesale Price Index (WPI)-based inflation in excess of a threshold of something like 5.5% reduces GDP growth, as various research papers have shown, including two in September 2011. This conclusion is also debatable. Is it the increase in WPI inflation beyond 5.5% that hurts growth—or are there other explanations for the correlation? For example, higher inflation may well lead to currency appreciation and, therefore, a larger negative number for net exports.

Again, don’t anti-inflationary monetary steps hurt growth? What about fiscal deficits? (One of the studies acknowledges these factors, but does not use them in its empirical analysis.) Too many accept without question that anti-inflationary policies are always virtuous because inflation is a regressive tax; because inflation hurts the poor most. True, but surely lower than optimum growth (and, hence, job creation) hurts the poor even more. As Nobel laureate Paul Krugman recently argued in his column in The New York Times, it is wrong to assume that “inflation is always harmful and always gets out of control". The worry is that the concept of a threshold inflation rate may become a self-fulfilling prophecy because of the corollaries it generates.

But to come back to the prospects for 2012-13, would steps to correct the macroeconomic balance—fiscal, current account, and inflation—and some economic reforms, considered as synonymous with liberalization, be enough to reverse the downward growth spiral? These are necessary conditions, but will they be sufficient? Or will the economy suffer the same fate as our cricket team—from world champions to down in the doldrums in 10 months? I would not rule out the spectre given the poor and worsening quality of governance—political, administrative and judicial; the breakdown of trust and communication between political parties, between the Centre and the states and equally between the governors and the governed. Add to this the populism which has brought major segments of the economy’s infrastructure—power and railways, for example—close to ruin, the way environmental concerns are inhibiting investment, etc. A happy new fiscal seems difficult to visualize. But the cricket team did register a miraculous win last Tuesday. Will the economy? Keep your fingers crossed!

A.V. Rajwade is a risk management consultant, columnist and author.

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