The RBI has made clear its intent to tighten monetary policy in the near future in no uncertain terms. Unfortunately, the reality of the growth versus inflation trade-off at this point in time does not support the RBI’s stated policy position. While there is anxiety about the rise in prices, it is largely confined to the price of food items which have little do with the underlying demand conditions in the economy. The inflation we are experiencing now is a supply-side phenomenon — inflation according to textbook economics can be either the result of excess demand or insufficient supply — and a supply-side issue cannot be addressed by monetary policy except in a very crude fashion. If there is a monetary squeeze for long enough, food prices too will fall but with considerable collateral damage to the real economy.

If on the other hand we look at the one indicator that does provide an accurate picture of underlying demand — credit off-take — the scenario turns out to be pretty bleak for growth. According to the latest data, credit growth dropped to a single-digit level (9.66 per cent on a year-on-year basis through October 23) for the first time in 12 years. In fact, the growth in credit off-take, an indicator of consumer demand and corporate investment plans, has been declining since August, ironically the same period that the RBI has started hinting at tightening monetary policy.

Needless to say, banks are playing safe — just as they have done since September 2008 — and have parked a record amount of funds with the RBI through the reverse repo window. Companies, aware of an imminent interest rate hike, are going slow on borrowing. With a view to protect their fragile profit margins, they are instead trying to access alternative sources of funds including the cheaper but riskier option of borrowing abroad. Smaller companies and individual consumers already face very high interest rate burdens, comfortably in double digits. The segment of the economy and population which does not have access to cheap finance — they cannot borrow abroad or via equity — is going to bear the brunt of the RBI’s irrational fear of inflation. Of course, if these segments suffer because of expensive money, then the economy as a whole will also pay a price in terms of lower growth, a price we can’t afford to pay.