There has been a rapid turnaround in the sentiment about the Indian economy in recent days. A few months ago, nothing could go wrong with the India story. Growth was high, inflation was low, foreign capital was flowing into India, the rupee was strong. Suddenly, everything has turned around. Industrial growth is down to single digits. Inflation is up to double digits. Interest rates are rising. Stock markets have seen a sharp fall. The rupee has weakened and foreign investors have turned away from India.
In terms of the domestic policy factors, it is the conduct of monetary policy that is the most important element in how macroeconomic policy was mismanged. In February the RBI engineered a rupee depreciation. In March came the inflation shock. Today, the inflation shock to the economy (the latest numbers show 11.4 percent yoy inflation) is one of the main factors responsible for the change in sentiment as well as for the slowdown through higher interest rates that it is now inducing as a policy response.
I think that the biggest policy mistake of the UPA was to run loose monetary policy for 4 years. The results of this policy have come to haunt it at a time when this government can least afford it. The RBI’s supposed attack on inflation through a hike in the repo rate is more posturing than good economic policy. In the last four years preventing rupee appreciation and risking high inflation was a policy choice made by the government and RBI. I think they failed to understand that the huge stock of liquidity in the system was as dangerous as it has proven to be. Read more