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Given the US financial trouble, what’s the prognosis for the Indian economy? Let’s look at that in some detail. A cyclical downturn is perhaps unavoidable, as our first leader argues. But there are also signs of improvement. Look at some of the headline macro numbers now. Inflation has fallen for three successive weeks, and even though it remains marginally above 12%, the downward trend is becoming clearer. The cause of falling inflation will, of course, be assisted by the consistent fall in the price of oil—it is now hovering at below $100 per barrel, the lowest in many months. The latest Index of Industrial Production figures reported a growth of over 7%, the best performance in more than five months. As our columnist on Saturday, Mahesh Vyas of CMIE, argued, this could anyway be a serious under-estimate given various methodological problems in the computation of our official indices. The overall economic environment that has greeted RBI’s new governor is better than the environment which saw off his predecessor.
The new governor’s task will obviously be to focus on inflation, but perhaps it will be easier for him to not hike interest rates any further in order to attain his objective. The time is actually ripe for a drawing down of our massive foreign exchange reserves, action that will help the rupee appreciate and cheapen imports. This will, as we have argued repeatedly in these columns, reduce the pressure on inflation more directly than an interest rate hike. It will cheapen imports, and reduce money supply, both of which will exert downward pressure on prices. There may even be a case for easing the interest rate regime—if supply constraints combined with excess demand are over-heating the economy, more investment, not less is the solution and that will not happen with high interest rates. Now is also the time for the new governor to push ahead with financial sector reforms regardless of the problems in the US. India, remember, is a massively underbanked, under-financed economy. And if interest rates are ever going to be an effective instrument of monetary policy and inflation control, then we need a thriving bond-currency-derivative nexus. Currency futures have made a good start. Now, it’s time to go beyond.
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