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On This Day - 8 NOVEMBER 2011
Do you prefer lower inflation or higher growth?
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So far, bringing inflation under control had been the primary objective of the Reserve Bank of India (RBI) as successive rate hikes in the past have proven. However, inflation has not yet come within the comfort levels of the central bank, but GDP growth has slowed down. India Inc. has felt the pinch on its profits as higher interest rates have taken their toll. So much so that there are increasing talks that the RBI should pause its tightening measures and give breathing space to the Indian economy so that it can grow.
But will that be in the interest of the average Indian? Indians have one of the highest savings rate in the world. And most of these savings are parked in government debt. The latter is predominantly internal (98% of GDP) and denominated in rupees and inflation brings down the value of government debt. Thus, a growth-oriented RBI may not bode well in the Indian context as India's debt is predominantly funded by domestic savers and inflation will hit the saving population the most. When inflation runs higher than the rate of return offered by provident funds, small savings schemes and bank deposits, it is tantamount to a huge tax on savers as seen in the last two years.
Thus, the average Indian is hit hard by inflation on two counts. One is by eating into savings, and the second is by indirectly weakening the balance sheets of institutions holding government debt. Moreover, because India does not have capital account convertibility, the saver cannot take his money out of the country. What this means is that although both the scenarios (notably higher GDP growth and lower inflation) are important for the well being of the Indian economy, when it comes to choosing between the two, inflation control should take precedence. After all, lower rate of savings will automatically make Indians wary of going on a spending spree and for India Inc, which is relying on the Indian consumption story among other things, such a development will only make things more difficult for business.
In addition, the rating agencies often provide consulting services to the rated clients thus cementing the conflict of interest. Ironically, none of this has changed in the last 3 years. In an interview to a business daily, renowned economist and Nobel laureate, Joseph Stiglitz gave some candid opinions on rating agencies. Stiglitz believes that the agencies are profit maximising firms that can make money by giving ratings. What really surprises us is that despite the regulatory whip and media criticisms, none of the rating agencies have attempted any change in their flawed business model. Moreover, most remain highly sought after by new issuers of capital.
At the same time, increasing labour costs and attrition rates have also brought margins under pressure for most of the IT firms. As a result, the big question now is what next? The industry needs to enter a new phase of growth and that can only be brought about through innovation and higher end services like consulting. These form a miniscule part of the industry's revenues currently. Only if the firms concentrate on increasing this, can they achieve the stellar growth rates that they have in the past. Otherwise, the Indian IT industry will most likely fall into the mature industry growth phase. And that would be much slower than their historic rates.
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