RBI: Is it suppressing Indian growth?

A blind obsession with inflation is hurting growth. Why are numbers not showing it?

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In the last post, we discussed how the RBI's policies hurt the poor more than the rich. In this post, let us examine if RBI is hurting Indian growth.

But before - The Basics

Economists like to compare the economy to a car. So, let us start from there.

If the economy is like a car, we will find that not all wheels run at the same speed all the time. The rich run faster and tend to run away, while the poor tend to lag and drag. Fiscal policy (run by the government, i.e. finance ministry) takes the energy from the rich and brings the poor up to speed (at least ideally). This way, we can keep the whole car (i.e., the economy) running at some decent speed.

But it cannot go as fast as it wants. There is a speed limiter that sets the limit for the maximum speed. The RBI runs the monetary policy (and regulates credit creation) that determines how fast this whole car runs. It is the speed limiter. At times, things get a bit crazy, and the RBI will come in and REDUCE the allowed maximum speed.

I believe the RBI is reducing the maximum speed far too much—so much that our car has to deliberately slow down to avoid crashing.

We are still growing at 7%, so why the big fuss?

There are two parts to this answer.

The current growth is making us struggle harder.

To normal people, growth felt easier in 2004-14 (more so between 2004-2009), and we had to grind harder during 2014-2024. Economists will tell you that the quality of growth between 2014 and 2024 was much better than that between 2004 and 2014. But to normal people, it does not feel that way.

This is because of the psychological effect of nominal GDP. The most quoted GDP growth numbers are REAL GDP. But in real life, we do not experience, feel or understand Real GDP; we experience nominal GDP. When a company grows at 10% every year, that growth is nominal. When we say our salary grew 10% last year, that was nominal growth.

Imagine a person who received a 10% nominal salary rise between 2004-14. With 8% inflation, the real growth was 2%. After 2014, the same 2% real growth with inflation at 2% translates to a 4% salary hike. How many of us would like a 4% salary hike vs a 10% salary hike even when both amount to the same real growth? No wonder the growth seems harder to get.

The main reason is that nominal growth during 2004-2014 was at ~15%, whereas during 2014-2024, it was ~10%. And that made all the difference.

But there is another reason - our growth is way below our potential!

Let us go back to the example of our car. Our car till 2014 was older, needed servicing and would heat up unnecessarily. Like our State Transport bus, everything in this car made noise, except the horn. When this car, I mean the economy was growing at 7%; there was no way this was going any faster. In fact, there was a chance it would break down or crash badly.

However, since 2014, we have made substantial investments in infrastructure, which have eased the bottlenecks. The government investments have targeted productivity and quality of life improvements. In other words, the government has overhauled, turbo-charged, and NoXed this car like on Fast and Furious. This car can now go very, very fast. The only thing keeping this car, I mean this economy, growing at 7%, is the artificial speed limit imposed by the RBI.

The RBI points to inflation, but is inflation the problem?

The RBI points to inflation as the main reason for its policy actions.

Much of the current inflation is caused by a rise in vegetable prices that are highly volatile and dependent on the amount and distribution of rainfall. Some prices have risen because the Government has incentivised them (by imposing import tariffs or promoting exports). These prices cannot be controlled by RBI raising interest rates.

The science of inflation is not so complex. It asks experts to be practical in their decision-making.

The Chief Economic Advisor, V Anantha Nageswaran, has highlighted the need for this practical decision-making in our fight against inflation. His two articles, Why RBI’s inflation regime is Broken and No inflation-targetting Framework is Sacrosanct, are worth reading. He even raises similar points to those we raised in the previous post—if we target the wrong kind of inflation, we will hurt the farmers. Unfortunately, the Mandarins at the RBI choose to ignore this wise advice, possibly in the name of institutional autonomy. The result is that the RBI is restricting the economy to influence the prices of things it cannot influence. It is like killing the patient to lower his fever.

The growth timing matters & now is already too late!

India has a unique window of opportunity, which will shrink by 2050 or 2060. We have a huge working-age population, and the time for growth is now.

This is the time to floor the throttle and rev it up. Holding back this country for some auspicious number to appear on the food inflation board is callous and whimsical and will badly hurt India’s future.

Delaying growth may scare the population into a low-growth mindset, leading to population implosion and entrenched deflation.

In Sum

While in the past, India was trying to make a truck fly, today, we are forcing a plane to drive on the road. If the RBI eases it up, this economy can show real GDP growth of 10-11% and nominal GDP growth of 13-15%. Growth will feel easier once again, and the quality of growth will be much better. Our hopes and dreams can take wing.

Yes, we can still grow slowly, but we want to simply take off. We don’t want your misapprehensions to choke our ambitions. RBI, I hope you are listening.

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Also Read

RBI: Fighting inflation or fighting the poor?

Rahul Deodhar August 2019: How Lower Inflation Lowered Economic Growth with Many Knock-on Effects

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