Thursday, July 25, 2024

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Monetary policy retards growth

By Anjan Roy

Two sets of data released during the current week, namely the GDP figures for 2010-11 followed by the figures for core sector growth in April this year, give fairly clear view of the state of the Indian economy. Two aspects will have to be distinguished in these data. First is the level of expansion of the Indian economy in 2010-11. The other is the rate at which this is happening. Confusing these two aspects should give rise to some confusion.

The Indian economy – measured by its gross domestic product or GDP — expanded by 8.5% in 2010-11. Earlier, it was expected that the economy should grow by 6.5%. So the actual against the target is not much different. At this level of expansion, Indian GDP growth must be one of the fastest. Given the state of the major global players, this is commendable [performance. More so in the face of the rising inflation rate which has continued unabated for almost a year now. Because inflation has meant anti-inflationary package of measures which inevitably dampens the growth triggers.

Here comes the second aspect of the growth story. While we are growing fairly comfortably but our pace of growth is slowing down. And this is a cause for concern. Unless the pace is restored we might in all likelihood end up in another overall slow-down as happened just about three years back. It will become evident once we examine the quarterly growth figures why these fears are not altogether wild and misplaced.

From the second quarter of the current fiscal year (2010-11), the quarterly growth rates pf the GDP are coming down. In the second quarter growth rate was 8.9%, in the third quarter 8.3% and now in the final quarter it dropped sharply to 7.8$. So virtually for last one year, we are seeing the economy is growing at a slower pace unabatedly. The nature of the slowdown also becomes clear as we look into the disaggregated figures of sectoral growth. It is clear, as we had pointed out earlier in these columns, that there is deceleration in the downstream industries following lack of fresh investment in these industries. Such developments can have long term impact.

The reason for this is being cited is the increasing tightening of the credit policy. When the Reserve Bank raised its interest rates during its last meet on May 3 that was the ninth straight time that interest rates were raised. This inevitably will have impact on , first, consumer demand and more importantly on investment demand.

The disaggregated quarterly figures clearly show that the mining sector, for example, has been slowing down and in the fourth quarter of the year it has reached rock bottom levels. In the second quarter of this year, mining grew by 8.2% and in the last this slipped to just 1.7%. This will mean that some of the vital raw materials for a variety of key industries will either run short or their prices should go up or worse, there will be shortages combined with higher prices. This has been happening to say coal. We have been hearing about reports of coal shortages hitting power generation and steel mills. At the same time, coal prices are said to be rising. So also was the story of the steel industry. The steel makers are threatening to jack up prices as raw materials costs are rising. The steel prices could go up by anything between Rs 600 and Rs 1,000 per tone, according to reports quoting steel industry top bosses. Coking coal and iron ore prices have firmed up by $50 compared to last year. Now, steel price increase means automobile price as well as a wide range of consumer durables like refrigerators or air-conditioners will also increase. Housing and construction prices should also be equally impacted. What we see is that neither coal, mining or iron ore mining industries have seen much investments for raising capacity which is leaving an impact on the upstream industries all the way to those which affect the consumer directly.

This trend of slower expansion in the basic and core industries – the foundations of an economy—is further confirmed by the figures released about core sector performance during April this year. Overall, the core sector has grown by 5.2% in April this year against 7.5% in April last year. The core industries include oil production and refinery output, coal production, electricity and gas generation and cement production. These are disturbing trends and should be reversed if the Indian economy is to maintain its high growth pitch as the government had earlier planned for the twelfth plan period.


The reason for this is being cited is the increasing tightening of the credit policy. When the Reserve Bank raised its interest rates during its last meet on May 3 that was the ninth straight time that interest rates were raised. This inevitably will have impact on , first, consumer demand and more importantly on investment demand. There are indications that the progressive hikes in interest rates are leaving such an imprint. There are reports that automobile sales are slackening. Next we should hear that consumer durables demand is also falling. These are likely to spread across the sectors. Higher interest rates, transmitted to the housing sector, will drastically hurt housing demand because the relative impact of even a small rise in interest will have major impact on housing demand. These are importantly early indicators of a deeper slow down. On the other hand, investment demand is critically dependent on interest rates because of the financing costs. Many investment projects will become unviable if the financing costs increase so project proposals will have to be redone.

However, this is not the sole reason for a possible slow down in investments. What we are witnessing is increasing environmental and political stumbling bocks. Few mining projects are taking off as environmental clearance is not forthcoming. Similarly, political problems with land acquisition has stalled virtually all green field projects. Investments are the triggers for growth and development. If these are throttled for a variety of reasons – be that financial or environmental or political — growth will become a victim. Are we seeing the early signs of that? (IPA Service)


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