A recent paper on ‘Growth or Austerity: The Policy Dilemma’, co-authored by the Prime Minister’s Economic Advisory Council Chairman C Rangarajan and secretary Alok Sheel, created a controversy when it referred to stagflationary tendencies in emerging countries like India. Many interpretations followed after the paper was published in the ICRA Bulletin - Money & Finance, with most saying India did not face stagflation. Rangarajan clears the air about this and other aspects of the paper in an interview with Indivjal Dhasmana. Excerpts:
Your recent article says stagflationary tendencies have already reared their heads in emerging markets like India. Your observation has been quoted in the media widely and evoked divergent views, mostly saying there are no visible signs of stagflation in India. What’s your take?
The paper you refer to was a full length 50-page academic paper published in an academic journal. This paper is not a policy paper or a paper about India. References to the situation in developing economies, including India, in the paper are only incidental, to highlight that the situation is very different in the two sets of economies.
The term used is ‘stagflationary tendencies’ in developing economies as a whole, including India, to describe a situation where growth below trend and high inflation co-exist. The paper does not use the word ‘stagflation’, which has a very specific connotation in economic literature. We are still growing at around five per cent (yearly) and I expect the growth rate to pick up further in the next financial year.
The article has also thrown light on the austerity-growth dilemma among advanced nations. Should G-20 ponder the dilemma as well, after it gave a coordinated solution to the crisis of 2008-09 and prescribe fiscal consolidation plans for the Euro zone?
They already are. This dilemma is reflected in the G20 communiques one way or the other. The place where the debate is most acute, however, is within Europe, and especially with the Euro zone, where the two heavyweights, Germany and France, have differing views. The peripheral countries in Europe are acutely experiencing the dilemma because of the unwillingness of voters to accept austerity and markets wanting fiscal consolidation.
Why do you say the dilemma is not faced to such an extent by developing countries? In India, there is such a heated debate on squeeze in Plan expenditure in the current financial year and the finance minister asked Parliamentarians to look around the world to buttress his point of view.
The dilemma faced by developing countries is similar but in some ways different. In advanced economies, growth has ground to a halt. Some countries are also experiencing a second recession. Despite large deficits, sovereign borrowing costs are at historic lows in many of these countries. However, in the case of developing economies, growth has only slowed. But they have the problem of inflation. This dilemma they have to resolve. Fiscal and monetary space is more constrained in these countries because of inflation and high borrowing cost.
You write that India, too, is finding that monetary policy is no magical tool to revive growth in an economy beset with structural market rigidities, high fiscal deficits and inflationary expectations. In these circumstances, monetary policy can only play a limited role. Then why do industry and even the finance ministry make such a hue and cry over rate cuts by the Reserve Bank of India?
Monetary policy in India has a difficult role to play. On the one hand, it has to tame inflation; on the other, it must stimulate economic growth. The reduction in interest rate can, to some extent, stimulate investment. However, the interest rate is only one among many factors which have a bearing on investment. We are taking steps to improve the overall investment climate.
For example, the constitution of the Cabinet Committee on Investment is an important step to speed investment and clear bottlenecks.
In this process, a reduction in interest rate might also help but the dilemma for monetary authorities persists because inflation simultaneously remains high. An inflationary atmosphere is also not conducive to investment. The recent decision to reduce the policy rate has been particularly influenced by the decline in the non-food manufacturing inflation to a more comfortable level of below four per cent. Nevertheless, it remains a difficult balancing act.