Recent evidence depicts a worsening growth picture. The slowdown is spread across components. On the consumption side, the trend decline in private and public spending from April 2011 and 2012 is accelerating with fiscal austerity. The weak consumer appetite is visible in the production counterpart; consumer durable goods, for instance, witnessed the biggest-ever fall (21.5% yoy) in over two decades last November. Imports, a key domestic demand indicator, are in double-digit contraction four months in a row and not just from reduced oil and gold demand; minus these, December imports fell 9.5%. Export growth, which slowed to 3.5%, just might portend a fading external stimulus; average export growth in November-December, at 4.7%, is about one-third that in the preceding four months (12.3%). And the last bastion of domestic demand, rural segment, is reported slowing, raising doubts about optimism related to a good monsoon.
This is a vicious spiral of down- trending growth. Even as policymakers are keen to revive investment, monetary and fiscal policies are constrained given high inflation and fiscal imbalance. Looking at the demand scenario and restrictive policies, the question is if investment can take off in such an environment. Something needs to give in to break this spiral. Can monetary policy provide that impulse?
Recall the route to growth unfolded by RBI in October. This, it stated, lay in strengthening foundations of growth by curbing the spiral of rising price pressures, while the revival of stalled projects and pipelines cleared by the Cabinet Committee on Investment would buoy investment and overall activity. A depreciated rupee and monsoon-boosted rural demand would be added stimulus.
Inflation developments are a mixed picture since. The December inflation data released this week confirmed that RBI’s foresight to keep interest rates on hold was well-considered. Both WPI and CPI headline inflation rates eased substantially, 1.29 and 1.36 percentage points to 6.16% and 9.87%, respectively, in December, as vegetable prices corrected sharply. Core-WPI inflation inched up marginally to 2.81% from 2.66% in November, but remains contained within the 3% bound. Core-CPI inflation, on the other hand, remains unmoving from its 8% range.
From a policy perspective, this doesn’t invite a monetary response at this juncture. The puzzle is that inflation which, RBI strongly argued from 2011 onwards, was due to fiscal excesses, refuses to subside notwithstanding sharp fiscal corrections for over a year (since October 2012). One possibility, looking at the difference in WPI-CPI signals,