According to Madan Sabnavis, chief economist at Care ratings, “Demand continues to remain weak as witnessed in the IIP data. As capacity utilization rates continue to remain low, an increase in demand could be met by raising capacity utilization levels. This means that there is no incentive to launch new investments. Consumption will rise only when inflation comes down.”
The Crisil report also points out that high inflation, “By discouraging consumption demand, eroding export competitiveness and raising input costs for corporates, has made the situation worse.”
But while inflation as measured by CPI has come down sharply over the past few months, economists expect the recent moderation in inflation to be transitory in nature due to the base effect and with continued uncertainty on the impact of a deficient monsoon on agricultural production.
Further, household inflation expectations continue to remain elevated. As higher inflation expectations drive up inflation which in turn reinforces the expectations, pursing a tight monetary policy to curb household inflation expectations which have been deeply entrenched, is being advocated.
On the other side of the debate is economist Surjit Bhalla, who writing in the Indian Express argues that “at least in India, monetary policy has had precious little effect on inflation”, RBI should cut interest rates to stimulate growth.
But, according to Aditi Nayar, senior economist at ICRA, “Higher interest rates are not the binding constraint to growth in several sectors. While a rate cut would boost sentiment and ease pressure on debt servicing, it may not translate into a major revival of growth unless issues related to land acquisition, labour issues and specific concerns for the coal and power sectors are addressed.”
As a majority of the projects which have been cleared by the Project Management group (PMG) belong to the power and coal sectors which remain engulfed in policy uncertainty, lower interest rates may not spur investment in these sectors.
The Central Bank is expected to continue with the tight monetary policy stance till the first quarter of the next financial year, by when inflation would probably be firmly under control. Thus, the government must bear the burden of boosting growth by improving the policy environment.