High inflation is a big hindrance to growth in our country. And the Reserve Bank of India (RBI) seems to be trying its damndest to try and help lower it. So much so that we think, that the governor D. Subbarao should even take to building warehouses. As per the latest figures, GDP growth in India slowed to a nine year low of 6.5% in FY12. It was widely anticipated that the RBI would cut rates in order to spur growth in the country. But, in the latest monetary policy review the central bank kept rates unchanged to the surprise of the economy. According to Subbarao, controlling inflation is the surest way to ensure the long term growth prospects of India. And cutting rates may have led to higher demand side inflation.
According to him, low inflation is an essential precondition to help secure growth over the medium-term. High inflation makes investment decisions uncertain. Wholesale Price Index (WPI) Inflation, as per the latest records sped up to 7.55% in May against 7.23% in April. The proportion of interest costs in total cost is only around 3%. Real interest rates (which are nominal rate of interest minus inflation) are lower today than what they were in the years preceding the financial crisis, when investment demand in the country was high. Considering that investments are sluggish, it means that there are other factors which are keeping them at bay.
So the important question is whether India's growth story is still intact? Well, according to the governor, we have an entrepreneurial, productive economy. Plus we have a large under tapped market, benefits of demographic dividend and potentially large savings pool. However, there is nothing inevitable about growth. We are suffering from a policy paralysis, and twin deficits. Without fiscal consolidation and a focus on taking tough policy decisions, days of heady 8-9% growth may be long over. While still driven by the whims of Foreign Institutional Investors (FII), Indian financial markets are now more mature, deep and resilient enough to absorb external shocks. We survived the balance of payments crisis in 1991, the subprime crisis in 2009, and we will surely survive this one as well. The government, the central bank, and the rest of the economy all need to work together to try and regain lost ground and get back to the erstwhile levels of growth.