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Friday, Aug 23, 2019

Trade-off between inflation and industrial growth

The fall in industrial growth is mainly the Reserve bank of India's (RBI's) making, writes DH Pai Panandikar.

india Updated: Sep 28, 2007 21:00 IST
DH Pai Panandikar
DH Pai Panandikar

It has been happening for nearly four months now. The rate of growth of industrial production has fallen steadily from about 11 per cent in April to 7 per cent in July. The official index of industrial production is however14 years old and may exaggerate the fall that has actually taken place.

The fall in industrial growth is mainly the Reserve bank of India's (RBI's) making. Overcome by the threat of inflation the bank had taken two specific initiatives. First, the RBI allowed the rupee to harden to curb excess liquidity caused by the inflow of foreign money. Second, the RBI raised the interest rates and the CRR to make credit more costly. The intention was to check inflation, which had crossed 6.6 per cent in March, and let the economy land softly.

The rupee hardened from 44 to 40 to the dollar in March and made our goods expensive to foreigners by 9 per cent and foreign goods cheaper to us to an equal extent. That hit our exports, in spite of the support given by the Ministry of Commerce, and increased imports to partly replace domestic production.

Of the total industrial production about 13 per cent finds market abroad. In April-July export growth was down to 18 per cent from 28 per cent in the same months last year and would have been responsible for a 1.3 per cent fall in industrial growth. Industries, which depend more on exports have slowed down faster. Metal products industry exports 18 per cent of its production, textiles and garments 25 per cent and leather and leather products 36 per cent. In most of these products the rate of growth of production dropped sharply. The import effect would have been more pervasive.

The increase in interest rate hit another set of industries, mainly those whose products are purchased on credit. Durable consumer goods like refrigerators, TV sets, air conditioners etc, cars and trucks, and a large part of machinery became more expensive or less profitable when the rate of interest was put up.

Since January this year the prime lending rate of banks rose a full 2 percentage points making credit 20 per cent costlier. The result was a fall in demand and consequently a cut in production. Truck production in July was down 9 per cent, 2-wheelers 11 per cent, TV receivers 24 per cent and so on. It looks like the drop in interest sensitive demand may have brought down industrial growth by more than 1 per cent.

The hardening of the rupee and the increase in the rate of interest may have pulled down industrial growth by more than 2 per cent. Perhaps the impact of interest rate may have been more extensive since it adversely affects the construction sector, which is a major buyer of a variety of industrial goods. The RBI is unlikely to ease the rupee in the near future. Industrial recovery will have therefore to depend largely on the reduction of interest rate.

(The writer is president, RPG Foundation)

First Published: Sep 28, 2007 20:55 IST

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