Coming on the heels of July’s 0.5%, the 0.4% growth of industrial production in August shows that the Indian economy is not on the road to recovery. The reason is the sustained high interest rate regime of the past four years. Industry has been begging for cuts in the cost of borrowing since March 2011.

When Prime Minister Narendra Modi came to power industry thought its troubles were about to end. But on August 5, RBI governor Raghuram Rajan surprised the country by announcing that he would not lower interest rates, because at 8% consumer price inflation was still too high. He also announced that he would not lower rates till inflation, measured by the cost of living, had come down to 6%. So his September 30 refusal to bring down interest rates came as no surprise.

But Rajan went a step further and unveiled an inflation forecasting model which estimated that under the very best of conditions CPI inflation would not fall to 6% till January 2016. To Indian industry, which ceased to grow three years ago, this was the kiss of death.

Today, there is not a spark of demand anywhere in the entire eco-nomy. In spite of every inducement, growth of credit in the festive season till the third week of September was Rs 1,52,430 crore against Rs 3,41,560 crore in the comparable period of last year. Two of RBI’s own reports have shown that capacity utilisation in industry has been falling since the early months of 2012. But Rajan remains fixated only on bringing down inflation.

What is worse he is using only one of four measures of inflation – the consumer price index (CPI) – and ignoring the other three. These are wholesale price index (WPI), RBI’s non-food manufacturing index (NFMI), and ‘core rate’ of inflation. WPI is an approximate measure of the rise in production cost. It is therefore crucially important for manufacturers and builders.

RBI’s NFMI is a rough measure of the pressure of excess demand on prices because it filters out the impact of weather and export policies on agriculture. But Crisil’s core rate of inflation is the most precise measure as it includes manufactured food items but excludes globally traded fuels and metals to filter out the impact of world commodity price changes.

Today, WPI inflation has fallen from 9.6% in 2010-11 to a record low of 2.4%. NFMI has also fallen from 8.4% in June 2009 to 2.8%, mainly on the back of declining world commodity prices. Crisil’s core rate of inflation is therefore higher, but only by 0.2%.

So why has the consumer price inflation rate remained so stubbornly high? The answer is that the new method of calculation introduced in January 2011 has, in an unforeseen way, become a measure of the effect on prices not of excess demand but of bottlenecks in supply and state failure to provide infrastructure for growth.

Primary foods – whose prices are determined almost entirely by supply constraints such as rainfall, area sown, and in case of vegetables amount exported – account for 42.2% of the index. Housing accounts for 9.77%, but the index includes only urban housing whose supply is severely constrained by shortage of urban land and sharp curbs imposed by government on loans to builders.

Health and education make up another 9.04%. The cost of both has risen because of drug price decontrol and a growing reliance on private doctors and schools that reflects the failure of the state. The only manufactured products included in CPI are clothing, bedding and footwear (4.6%) and manufactured foods (8.2%). If housing is taken as a proxy for basic industries, total weight of manufacturing in the index comes to just 21%. The rest of this index reflects constraints in supply that high interest rates cannot remedy.

This is why four years of ‘inflation targeting’ using CPI as the yardstick have failed to make any dent in CPI inflation. Today, people are expecting that RBI will lower rates, but only because CPI inflation has fallen to 6.46% and, with diesel prices falling, will go lower. But the cause – a sharp fall in world commodity, and particularly oil, prices – has nothing to do with India. And we have no idea how long this fall will last. Should domestic interest rates go up again if ISIS captures Basra or China goes on another investment spree?

Government has belatedly realised that interest rates determine not only money supply but also economic growth. So it is setting up a joint finance ministry and RBI panel to decide what these should be. But even this is not a sufficient safeguard. Cong-ress learned to its cost that inflation indices misinterpreted and interest rates misapplied can not only sink the economy but the government as well. If interest rates are to be indexed to inflation it must be to the core rate of inflation, and be subject to whether government wants growth or price stability. That is a decision only the cabinet and prime minister are qualified to make.