Now that we are ostensibly at the end of the current monetary tightening cycle one that has failed

d to control inflation even while stifling growth it presents an opportunity for some stocktaking. The questions to ask are: Why have the Reserve Bank of India's (RBI) traditional monetary policy tools, including 13 hikes in its lending or repo rate since March 2010, not worked this time? Rather, could they have ever worked? And most important, in the light of all this, what are the prospects now for inflation and growth? Some answers can be found in the accompanying chart, which plots year-on-year growth rates for the general index of industrial production (IIP) and the all-commodities wholesale price index (WPI) from April 2006. Booms and Busts What broadly emerges is the following: 2006-07 and 2007-08 were golden years where high industrial growth co-existed with moderate inflation. The IIP went up by an average 12.8 per cent during 2006-07 and 15.7 per cent in 2007-08, even touching 20 per cent in the odd month or two. The corresponding WPI inflation levels averaged 6.6 per cent and 4.7 per cent. The heady growth trend was maintained through the first half of 2008-09. That same period, however, also saw the WPI inflation rise to cross double-digits towards June. It was a clear case of an overheated economy that plausibly lent itself to conventional monetary tightening treatment. The RBI acted accordingly, raising the repo rate by 125 basis points to nine per cent between early June and end-July. But this phase did not last long, courtesy the collapse of Lehman Brothers in mid-September and the Great Global Recession that ensued. The graph shows inflation receding from around November 2008 and dipping thereafter quite rapidly to enter negative territory in June 2009. Even sharper was the IIP deceleration from 10.9 per cent in September to seven consecutive months of negative growth between December 2008 and June 2009. That made it a recession' in the textbook definition of a contraction spread over two or more quarters in a row. This was again probably amenable to the usual treatment, even if in the reverse order of monetary loosening. The RBI did precisely that, by bringing down the repo rate to 4.75 per cent by April 2009. These, in conjunction with the Government's own fiscal expansion measures, worked. Towards end-2009, industry began to recover, though that was the time when prices, too, started surging. The WPI inflation rate has, from January 2010, been hovering above eight per cent and at nine per cent-plus since December 2010. The 375 basis points cumulative repo rate increase effected since March 2010 has apparently made no difference. While inflation has remained stubbornly high from 2010, there has been a decline, however, in IIP growth in the more recent period: From an average 7 per cent during the April-June 2011 quarter to 3.8 per cent in July, 3.6 per cent in August and 1.8 per cent in October. Sticky prices The most striking trend from the above is the persistence of inflation, at eight per cent or more for the past almost two years. It is, in one sense, a mirror image of what took place in 2006-07 and 2007-08 a period that posted as many as 25 successive months of nine per cent-plus IIP growth.

If the latter led to an overheated economy albeit for a brief period what the sustained inflation of the last two years would, contrariwise, have done is erode the purchasing power of consumers. The reduced consumption demand from that which takes time to manifest itself might perhaps be one of the reasons for the slowdown noticeable from the July-September quarter. This is also borne out by declining car sales and a lacklustre Dussehra-Eid-Diwali festival season reported by most consumer durables manufacturers or gold jewellers. While persistent inflation may well be a cause of the industrial slowdown now underway, how does one explain the persistence of inflation itself? Inflation, we know, can be driven either by excessive demand or inadequate supply (or a combination of both). The 2008 inflation was, by all indications, demand-led: There was an overheating episode, which was cut short, though, by Lehman Brothers. The 2010 and 2011 inflation, by contrast, have had less to do with demand as much as supplyside factors. Unfortunately, the RBI does not seem to believe so, the latest evidence of that thinking coming from the Governor, Dr. D. Subbarao, himself. In an address earlier this week, he identified inclusive growth policies such as MGNREGA and shifts in dietary habits towards protein foods accompanying rising incomes as stoking inflationary pressures. In other words, inflation resulting from, what economists would call, a rightward shift in the demand curve. The right shift So, what is the solution? Is it to restore back the demand curve to its original position, which is what the RBI or at least its policies would appear to suggest? Or is it to shift the supply curve, too, rightwards? The RBI's preference to raise interest rates, if anything, has only stifled supply response by eating into the profits or investible surpluses of firms and disincentivising them from augmenting productive capacity. In the process, it has contributed to a slowdown, while not curbing inflation either. The coming months are likely to witness an aggravation of the slowdown on account of a further moderation of both consumption as well as investment demand. That, ironically, may help rein in inflation, just the way persistent inflation has been responsible in slowing down growth.

A slowing economy will help bring down inflation, something that successive rate hikes have not achieved.