Competitive Exams: Current Affairs 2011: Macro-economics

Evaluating the macro-economy

The Reserve Bank of India's latest annual report, released recently, makes a candid assessment of the macroeconomic performance during 2010 − 11 and the prospects for the current year.

Although the economy returned to its high growth path, it faced several challenges: Investment activity slowed; fiscal consolidation was led by cyclical and one off factors casting doubts on its sustainability; and inflation remained stubbornly high on the back of new pressures.

The RBI responded to the challenge of inflation by raising policy rates by 4.75 percentage points on a cumulative basis from March 2010.

The report points out that high inflation by itself would have brought down growth. When inflation is high, the theoretical tradeoffs between inflation and unemployment or between inflation and growth do not work. Well into the current year, inflation has continued to be the number one concern for policymakers. The RBI is poised to raise interest rates further even though it is well recognised that some of the growth momentum will be lost in the process. Indeed, the lower GDP growth at 7.7 per cent in the first quarter is partly attributed to the high interest rate environment.

The RBI's GDP growth projections for the current year have been more modest than those of the government.

However, even with the expected deceleration, growth is likely to remain close to the trend of about 8 per cent. Inflation is expected to remain high for the rest of this year and moderate to about 7 per cent by 2012.

In the absence of supply side responses, monetary policy has its own limitations as an instrument for curbing inflation, although it can still play an important part in countering the second round effects of supply led inflation.

On current assessment, the fiscal deficit this year is likely to overshoot the figure anticipated in the budget. The deficit will widen further, if the economy slows down, as feared, and the revenues drop sharply from the anticipated levels as a consequence.

On the other hand, the current account deficit can be contained within a sustainable level of 2.7 3 per cent of the GDP. However, the outlook for the external sector during 2011 12 looks uncertain. The annual report lists six medium term challenges for the Indian economy. Predictably, bringing inflation and inflationary expectation down to acceptable levels tops the list. It is one thing to get the diagnosis right; it is yet another to come up with the remedy.

Courtesy: The Hindu and Times of India