The Tug-of-war: Inflation vs. RBI

With falling industrial production, rising inflation and worry over meeting the fiscal deficit target are showing signs of economic slowdown in the Indian economy. But the main concern for economy is falling private investment in the economy. The slow investment or falling investment simply means the capacity lack or slow expansion in the economy. The main reason for this slowdown in investment in the economy is mainly because of tag-of-war between RBI’s monetary policy and crude oil price lead inflation, however, the RBI is failed to bring inflation to its comfort zone.

This tag-of-war between central bank and inflation is likely to continue in present financial year as the international crude oil price is expected to remain at elevated level. In last financial year RBI has increase its policy rates by 8 times to tame curb inflation. Yesterdays, wholesale price index (WPI) inflation rose to 9.06% for May, this higher than expected inflation has set the stage for tenth hike in a row at its mid-quarter review on 16 June.

Looking at the other economic indicators, like core infra industries and industrial production, this tenth hike in interest rate will hamper economic growth in a major way. Government is hoping that the good monsoon will boost agriculture and ease pressure on food inflation, which reached to two month high level for week ended on 28 May.
The slowdown in April’s industrial production was expected because of due to slow expansion in six core infrastructure industries which account for almost 27% of Index for Industrial Production (bases year 1993-94), the six core infra industries rose to 5.2% compared to 7.5% in the same month of last year, as a result April’s IIP was at just 6.3% down from 8.8% of March and for below from the double-digit growth of last year.

In May, India’s export registered impressive growth of 56.9 percent to $25.9 billion, whereas imports for the month rose 54.1 percent to $40.9 billion. However, the trade deficit raised to 67 percent in May from last month to $15 billion, this three year high increase in trade deficit is due to increase in demand for oil, gold and industrial machinery.

Country’s export sector performance in last two month has been outstanding, the export for May grew by 57%  to $ 25.6 billion and import grew by 54.1% to $ 40.9 billion, however, the trade deficit surged to 67% which is three year high level, due to increase in import of oil and gold. But the coming month for the external sector will be difficult as the global economy is still recovering, and debt crisis in euro zone, demand is expected to reduce from western markets for the domestic goods.
The demand scenario in domestic front is also showing the signs of moderation, the demand for passenger car have registered a fall, indicating the high inflation and rising borrowing costs starting to affect consumer durables segments.

The slowdown in economic expansion is visible in all the sector of Indian economy, the industrial production is likely to fall in coming month as the high interest rate constraining the investment climate, external factors high prices global of food, energy and commodities making obvious that inflation will not come down in coming months. RBI’s aggressive monetary policy stance on inflation has increased the cost of capital; this increased borrowing cost has hit the growth and investment plan of industry in short and medium terms, which in turn contribute to slowdown in economic growth rate.

Because of tag-of-war between inflation and RBI, the Indian economy 's growth is less likely to bounce back in for the present financial year.