Elevated inflation and high interest rate are hampering economic expansion in short and medium term

Inflation is less likely to fall in coming short and medium term due to global factors and RBI is also expected to maintain its aggressive monetary stance on inflation, high inflation and high interest rate are hurting country’s growth in short and medium term. This slow down in economy is evident from the falling industrial production; rising inflation and worry over meeting the fiscal deficit target. However, the main anxiety for economy is coming from diminishing private investment rate in the economy, the gross fixed capital formation had reduced to 0.3% in 2011 as compared to 14% in 2010. The slow investment or falling investment simply means the capacity-lock or slow expansion in the economy. The main reason for this slowdown in investment in the economy is mainly because of tug-of-war between RBI’s monetary policy and crude oil price lead inflation.

This tug-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. Since the last financial year RBI have increased its policy rates by 9 times to curb inflation. The 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 six core infrastructure industries and industrial production, this tenth hike in interest rate will hamper economic growth. Government is hoping that the good monsoon will boost agriculture and it will reduce the food inflation, however, food inflation is falling from January. The slowdown in April’s industrial production was expected because of slow expansion in six core infrastructure industries. 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. The six core infra sector accounts for almost 27% of Index for Industrial Production (IIP) (as per the 1993-94 base).

Country’s export sector performance in last two months has been outstanding export grew by almost by 45% to $49.8 billion whereas import raised by 33.3% to % 73.7 billion and trade deficit for the same period were $ 23.9 billion. 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 export sector will be difficult as the global economy is still recovering, and debt crisis in euro zone will affect the demand 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 sectors of Indian economy, the industrial production is likely to fall in coming month because of high interest rate which is reducing the investment in the economy, other factors high global prices 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.