columnist is a senior economist at the macro modelling and
forecasting division of the National Council of Applied
Economic Research (NCAER). Since completing her doctorate at
the University of Surrey she has been tracking developments in
the Indian economy. She is editor of the "MacroTrack", NCAER's
quarterly update on the economy. |
When the going gets tough
Policy-making is easy when inflation is low and
growth high, but very hard when things are the other way
around. Like in India right now where inflation has already
inched to above 7% and industrial growth is declining. And as
December grinds on, the main policy issue is: which of these
should the Finance Minister target first, inflation or growth?
The dilemma is stark: in the short run, success in one
can only come at the expense of the other. But let's assume
that inflation weighs more heavily on political minds and that
the government is therefore far more likely to target
inflation immediately and worry about growth later. If so,
what can we expect?
Artificially paring inflation figures has its
adverse side effects
The monetarist approach to bringing inflation
under control is simple: reduce money supply and raise
interest rates. So should the RBI now tighten monetary policy
to control inflation? When the rate of economic growth was
comfortable, the RBI only had to worry about inflation and
could tighten monetary policy if necessary. When growth is
low, as at present, a higher interest rate may help to reduce
liquidity and lower price rise, but it would hurt the industry
To turn the industrial slowdown into a
full-blown recession, perhaps all that needs to be done today
is to raise interest rates. So tightening money may not be an
attractive proposition. Also, RBI Governor Bimal Jalan has
promised that interest rates will not be changed and that
inflation cannot be the only objective of the central bank.
This indicates that the RBI is unlikely to tighten monetary
Deficit financing to reconcile the policy
But what about fiscal policy, then? What policy
choices does the government have, particularly in terms of
financing the deficit?
Let us for the moment assume
that the Finance Ministry uses every possible means to keep
the deficit under control. But there will still be a policy
conflict between controlling inflation and raising growth. The
larger the market borrowings of the government, the higher
would be the pressure on interest rates.
alternative is monetisation of a part of the debt or deficit
financing, as it is popularly known in India. The government
could borrow from the RBI or, in other words, print money. By
reducing the share of financial savings being pre-empted by
the government, monetisation frees up resources that can be
lent to the private sector. It not only reduces the interest
burden on old debt by lowering rates, it reduces the real debt
as prices are higher. It raises GDP as more and more projects
become attractive when interest rates fall.
given that the current underlying inflation rate is still low,
deficit financing may not translate into an increase in prices
for a long time. There is usually a time lag involved in the
transmission of monetary policy. One would hope that the time
it takes for higher money supply to translate into higher
prices is long enough so that deficit financing starts pushing
up prices, if it does, only after the current supply shock
inflationary phase is over.
Monetisation may be the last option available to
The trouble though is that while monetisation may
not have been an unacceptable option, say last year when the
inflation rate was just over 3%, it may not be a very popular
option today when the rate has already crossed 7%.
Even though the underlying rate is low, it is the
headline rate that determines the popularity of a measure.
Also, considering that this means of mobilising resources,
which was widely used in the 80s, has been out of fashion in
the 90s, and it may be difficult for the Finance Minister to
revert to it. Indeed, it may be said that the Finance Minister
lost his chance to reduce the overall size of government debt
when he did not consider monetisation as the preferred option
in the last two budgets when inflation in the country was low.
It may have found favour more easily then.
So, what can
the finance minister do in this budget? Either, he can borrow
to the full extent of the fiscal deficit in the market and let
the size of government debt put pressure on interest rates and
hope that some miracle would ward off the recession. Or, he
can monetise part of the deficit, reduce the pressure on
interest rates and lower public debt. And although this may
raise a few eyebrows, if inflation does not go up further
during the year, his gamble might pay off.
To view more articles by the
author, just type Patnaik in
the Keywords search and hit go!
Copyright © 2000
Sharekhan.com & SSKI Investor Services Ltd. All Rights
The views expressed in
this column are those of the author and not of the institution
to which she belongs. Also, Sharekhan may or may not concur
with the views of the author. We do not represent that it is
accurate or complete and it should not be relied upon as such.