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Rajan targets inflation, now will government go after growth?

September 20, 2013 18:16 IST

Image: Raghuram Rajan.
Photographs: Sahil Salvi/ Amberish K Diwanji

But economists point out, pushing down inflation, by making the cost of money, or interest, high, also pushes down growth.

When IIT & IIM alumni Raguram Rajan took over as the Reserve Bank of India governor, some newspapers and TV business news channels went gaga. 

He was treated as the messiah who would rescue India from its current economic mess of growth stagnancy and high inflation. Stagflation was well known in the 1970s, it was least expected to make a comeback in India in 2013, more than two decades after India liberalised.

But if the TV channels are to be believed, Rajan’s honeymoon ended today after he unveiled his maiden monetary policy.

The markets took a swift tumble, though they began to recover after that, and particularly after he held a press conference (that Rajan has chosen to meet the media after announcing his policy is a welcome step towards more transparency).

Conventional economic wisdom links inflation to high growth. It is simple. If there is rapid growth, there is more money, which in turn pushes up the price of items (because there is a time lag between demand and supply). Thus, high growth comes at the cost of inflation, if all things are right.

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Rajan targets inflation, now will government go after growth?

Photographs: Sahil Salvi/

Now comes the political conundrum. The salaried class, or middle-class India, cannot tolerate inflation, which effectively erodes the value of their salary. But the very rich and the poor (especially those in the unorganised sector, which comprises over 90 per cent of India’s labourers) both prefer growth over inflation.

For the rich, a growing economy, where money is available easily, is preferred since it allows for more investment and more projects to be set up and gives them a chance to grow richer.
Paradoxically, the poor too need growth. Since they receive no regular income, more growth means more job and work opportunities, which translates into more avenues for income.

But traditionally, in India, inflation has mattered more than growth. Thus, while Indians have loved pointing to China’s rapid economic growth of around 10 per cent for a decade, what was missed was the high inflation accompanied the growth (it went over 20 per cent in 1994).
In fact, in the early 1990s, then Finance Minister Manmohan Singh had categorically said that India could not have a very high growth rate (read over 10 per cent) because it would never tolerate inflation of 20 per cent.

But as economists point out, pushing down inflation (by making the cost of money, or interest, high) also pushes down growth. At present, the media has been flaying the government for India’s low economic growth this year (expected to be 5 per cent of GDP). Yet, the people have forgotten how they blasted the government when inflation zoomed, as it did in 2009 and 2010, to around 10 per cent and 12 per cent respectively. The cry then was to curb inflation forthwith.

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Rajan targets inflation, now will government go after growth?

Photographs: Reuters

Let’s be honest. With elections just eight months away, no government (or government institution) will allow inflation to jump. It is a recipe for losing elections. Remember the 1970s!

In the early 1970, it was the massive inflation (caused by OPEC suddenly hiking petroleum prices in 1973) of food prices that led to widespread street protests.

The people’s mood wasn’t just sombre, it was angry (as an aside, a child of that era was Amitabh Bachchan, who emerged as the Angry Young Man, an outlet for the people’s frustration). The riots, Jayaprakash Narayan’s challenge, and a court ruling led Indira Gandhi to impose Emergency.

This in turn led to her defeat in 1977, the first time the Congress had lost elections. Inflation was blamed as the primary culprit.

But an alternative reading to the 1970s is that if India had good economic growth, if people had opportunities and hope, then perhaps the anger against Indira Gandhi would have been less. Granted this is in the realm of possibilities, but one can’t help wondering if Raghuram Rajan (and the government) missed a chance.

Still, having said that, the RBI governor’s job is monetary policy, which means keeping inflation in check, Rajan did his job today and may still be the messiah we await.

Now, it is time for Manmohan Singh and Chidambaram to do their jobs, ie, push economic growth. Or prepare to lose the next elections. And this time, the culprit is growth, not inflation.