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Inflection Point

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Economic policymaking is stuck between a rock and a hard place, and we are running out of blasting powder. On 12 June, the index of industrial production (IIP) data, a good proxy for manufacturing growth, continued the downward slide, confirming that the economy is close to plummeting like a rock into a chasm.

Meanwhile, the country's political establishment (including the Opposition) is fighting a battle over who should be India's next President, and all sides are sticking to their hard positions.

On 11 June, Standard & Poor's (S&P) suggested it might lower India's investment grade rating. Inflation shows no signs of abating (it grew 7.55 per cent in May 2012 over May 2011 and broadly in line with expectations) and yet, everybody expects the Reserve Bank of India (RBI) to cut policy interest rates to spur economic activity in its mid-quarter monetary policy review on 18 June.

A cut in interest rates will not kick-start the investment cycle that will revive GDP growth, but it will push the consumption cycle, which had shown some signs of moderation in the IIP. That is bad news for inflation. Core inflation is directly linked to international commodity prices, and there is great uncertainty on that front.

Despite all the cries from industry for the government to do something, there seems little that can be done.

Perhaps that is as it should be. Inflation will abate when there is a real reduction in demand (what economists call demand compression), and we haven't reached there yet.

All the various attempts to control prices are showing up in the value of the rupee, which remains weak (a depreciating bias so to speak).

If the RBI does not cut interest rates at this time, things could get worse, rather than better.

It never rains, but it pours, so let it.

(This story was published in Businessworld Issue Dated 25-06-2012)