Indian economy is not demand constrained, it is supply constrained...

"Indian economy is not demand constrained, it is supply constrained."

India's real GDP at 5% is good, not very low, when rich countries are doing at 2%. China is growing a little better at 7%, exports are an advantage. Believe me their nominal GDP must be much higher...

To be more exact, INDIA’s nominal GDP growth rate is equal to real GDP plus inflation means, 5% + 10% (inflation, CPI) = 15% which is not sustainable because inflation is too high, Income, consumption, and saving/investment is lagging behind. It is so high that no bank is giving 15% interest on savings a year. Bank is increasing income 8% a year. However, public and private spending is rising under compulsion under price-rise… 

In the long run when inflation is assumed zero, real GDP growth rate will equal nominal GDP growth rate in equilibrium. The long run potential GDP growth rate of the Indian-Economy is 12% because its population growth rate is 17% (every ten year), and, deducting frictional unemployment of 5% it comes to 12%, the rate of growth of labor force and employment to maintain full employment. Therefore India's full-employment long-run potential growth rate is 12%. And, under equilibrium full-employment long run potential GDP growth rate (12%) = nominal GDP growth rate (12%) = real GDP growth rate (12%). But, the situation is 12% = 15% = 5%.

 The last one, the real GDP growth rate is a long run goal. In the short run we have achieved the target with nominal GDP growth rate at 15%. Indian economy is at full employment with all the supply side constraints. In 2012 the unemployment rate for Indian-Economy fell to 3.8% which is why inflation is so high and persistent. We can not achieve 12% real GDP because we can not tolerate inflation above 10%. The benchmark we have set for our selves. We need patience. No doubt inflation is the major problem… (edit.)

There is absolutely no doubt about the growth potential... the doubt is about when... when we would be able to reduce the interest rates... And, that will happen when inflation comes down to our target (5%)...

As soon as the food-inflation comes down with the implementation of the Food-Security-Bill we will have more room for aggressive monetary easing. We are worried about foreign inflows even when our interest rates are high due to elevated inflation... There are three major sources of liquidity, liquidity from monetary policy, liquidity from fiscal policy and liquidity from foreign sources. We although pursued a tight monetary policy but we never disallowed investment from the other two sources… We were worried about drying-up of foreign sources because we can not reduce interest rates at home because of high inflation. Nevertheless the CAD was a concern… we needed to improve our foreign exchange reserves for a good rating… Therefore, liquidity can come from any or all of the three major sources. Therefore, again, we need not to worry about foreign currency outflows because when capital will leave your shores that would also bring inflation down and we have a room for loose monetary policy at home. QE is an unconventional monetary policy which is poised to go down one day; if QE dries-up we can easily cut-back on interest rates and improve liquidity to the economy but only when the Food-Security-Bill is implemented and inflation comes down close to our target. Demand for cereals has a considerable weight in the CPI and the government has enough stock of food. If inflation and supply side factor are considered it is a structural problem because due to high inflation, especially oil (we can do little about) and food, which are stuffed in government coffers. It is all the indifference of the government which has made prices overshoot the inflation target, and this is about food and food prices... Therefore, if prices are high due to mismanagement of the government and fiscal spending (too much), it is a structural problem. Liquidity I do not think is a problem since inflation is high and prices are a problem, too much money chasing the government food stock. It is important to bring Food Security bill than to attract FDI in multi brand retail. Both are aimed at controlling inflation by removing supply side bottlenecks for food. The demerit of FDI in multi brand retail is that it makes us dependent on foreign capital inflows. I agree that FDI's are long-term investments but food-security is in our own hands and we are delaying its transmission to higher growth rate because high food prices are stopping us in from lowering interest rates…  Fiscal policy has pumped so much liquidity in the system that the economy has reached its limits pushing the prices above the roof in the face of higher wages/income. Both monetary and fiscal can give demand a boost... Therefore liquidity is coming out of fiscal policy. The RBI while manipulating interest rates should also take into account the Fiscal-Deficit. Everybody is admitting that it (the deficit) is high including rating agencies… The rate of inflation may be gauge of liquidity in any system, we even make use of the notion that “more money supply, more inflation”. Therefore, money supply can also be increased/decreased through fiscal policy, too... I’ve heard many people saying that there is a problem of liquidity but when we see the rate of inflation (above 10%) we have a “real-gauge of liquidity” too. I think our (new) Governor will take fiscal deficit (too) into account before deciding for interest rates. I think we have case for increasing interest rates…

The government should aim at removing supply side bottle necks and the RBI should take care of the finances by manipulating interest rates...

What a 25 basis point will do when inflation is in double digits? To be precise, the RBI, for every extra percentage of inflation, should increase interest rate by more than one percent (The Taylor-Rule). Therefore, if the RBI inflation-target is 5% and we have inflation rate of 10% we, at least, need to increase interest rate by 500 basis points. This is not unimaginable… Way back during 1970s, in the US, the Fed’s head Paul Volcker raised interest rate from 11% to 21%... But the unemployment rate rose to 10%. I do not know way back, then, in the US had the kind of unemployment-benefits it has, now. These benefits show our tolerance towards unemployment… Unluckily INDIA has no such mechanism that decides our tolerance towards inflation and luckily real-unemployment (deducting after the various types of unemployment) is not a big problem. It is near 6% (as per our FM), manageable. Therefore unlike the US, in the absence of any unemployment benefits, INDIA can tolerate less unemployment to let the prices cool down. I’m not expecting a knee-jerk reaction but during a slowdown when the source of income dries-up a lower inflation is like an ointment… I can easily expect the RBI to raise interest rates some more. Capitalists will be benefited by the action and the lay man’s relief due to lower prices.  Economists have a good image of “the” Paul Volcker.

It is also expected because lower prices is a relief for all, especially food and oil prices, and when we lower prices by increasing interest rates it is also good for investment… our savings and yield on savings increase… we become richer… Therefore, it is in the interest of the economy to lower prices by increasing interest rates…  An inflation rate of (above) 10% is enough for invoking monetary policy action… We can easily expect another rate hike in the October review.The stock market in INDIA is very responsive, it is responding on all the relevant information. It is active... We in INDIA have subdued the demand pressure by not reducing interest rates... Industry is waiting for rate-cuts so that they can resume (investment) spending... But after the September rate hike the Industry is worried about another such action from the RBI considering high inflation (food and fuel)… Therefore, it is in the interest of the economy to lower prices by increasing interest rates…

We in INDIA are over-employed we are working longer hours and are paid less than our developed country counterparts. “INDIA IS OVER-EMPLOYED” not unemployed. Unemployment is not a problem therefore we need to look at inflation…