1. Introduction
This paper investigates the possible existence of threshold inflation in inflation-growth
relationship for India. For more than last thirty months or so, inflation in India has kept
policy makers off guard.1 In the situation when economy is recovering from worst hit
financial crisis, where global and domestic demands are bound to register strong growth
high and persistent inflation, is not only worry for Reserve Bank of India (RBI) but for the
fiscal policy also. As India’s main growth driver—corporate investment—is yet to catch
the trends of 2003-08 periods, when investment growth was around 16 percent. This means
that during 2008-09, no industrial capacity has been created. Now, once the global and
domestic demand will shoot-up, investment has to increase, this will further add pressure to
the existing high inflation in upward direction. In this backdrop, it is essential to revisit the
old question -what is the tolerable level of inflation for policy makers in India?
Relationship between inflation and growth has been much asserted both theoretically and
empirically in macroeconomics. For most of the time before 70’s debate on inflation-
growth relation dwindled between the arguments that either there is no relation or the
relation is positive. The period 1970s, which is marked by high inflation and low growth
brought a profound change in the existing debate of ‘no’ or ‘positive’ link between
inflation and growth. But again, the experience of the 1970s could not contribute much to
the existing debate other than adding third dimension of ‘inflation hurts growth’.
Thereafter, a large number of theoretical and empirical studies fueled the support to
position that however, high or low inflation adversely affects growth. Study by Sarel
(1996) made a distinction in this debate. Sarel (1996) attempts to study the inflation—
growth link in light of a threshold inflation beyond which inflation hurts growth and
concludes that an threshold inflation of about 8 per cent for a pooled sample of a large
number of countries, including India. Later, Khan and Senhadji (2001) estimate the
threshold level of inflation for both developing and developed countries separately using
non-linear models.
There is handful of studies in the Indian context which earlier examined the threshold level
of inflation for India. The Chakarvarty committee (1985) which was set up for monetary
reforms had put-up 4 percent of inflation as threshold inflation. Later in the mid-1990s, the
then RBI governor, C. Rangarajan (1998), brought Central Bank focus on inflation rate at
6-7 per cent known as “acceptable level” of inflation. Study by Vasudevan and Dhal
(1998) and Kannan and Joshi (1998) found the threshold level to be around 6 percent.
Results of Samantaraya and Prasad (2001) are also on the similar line as they found the
threshold level to be around 6.5 percent. In a comparatively recent study, Singh and
Kalirajan (2003) provide argument against any threshold level for India, contrary to the
studies mentioned earlier.
Given the present condition of persistent high level of inflation in the Indian economy and
its implications for monetary and fiscal policy both, it will be of interest to estimate the
threshold level of inflation, if any, in Indian context to understand the significance of
1 For a very short period (March 2009-October 2009) inflation was low and for some time during this period
even negative but again it to its running trend of near to double digit around March 2010.