Economic Highlights

New Delhi, 19 March 2008

Mounting Inflation

WORRY ABOUT GROWTH, NOT PRICES

By Dr. Vinod Mehta     

Former Director, Research, ICSSR

Having dipped below four per cent, the rate of inflation has again surpassed the five per cent level.  Some economists fear it may go over six per cent.  The increase in prices have come at a time when there has been some slowdown in the growth of the domestic manufacturing sector and the fear of worldwide recession especially in the US, which may affect our exports and indirectly affect the growth of the economy in general.

This is indeed a very difficult situation for the government in power especially when elections, both in some States and the Centre are due.  If the choice is between growth and inflation, it makes sense to choose the former and ignore the latter. For inflation can be tackled through short term measures like imports in weeks or months, but if we lose the growth momentum it will take years to regain it. It has taken almost 50 years to raise the growth rate by about three times from almost three per cent (the so-called Hindu rate of growth) to nine per cent today.

Inflation strains the budgets of families with fixed incomes and erodes their real incomes, whereas higher growth impacts the entire economy. It brings in more revenues to the Government, leading to creation of more productive assets and jobs.  Therefore, an ideal situation would be when the growth rate is higher and rate of inflation modest. But, in real life we seldom get such ideal situations.  The Governments of the day have no option but to manage with whatever options are available at that particular point of time.

One thing is quite clear -- if the rising prices, especially of daily necessities are not controlled, the ruling party/coalition is bound to suffer at the elections.  We seem to be facing the same situation as we did during the same period last year. The rate of inflation which was about 5.5 per cent in January 2007 had increased to 6.5 per cent in February 2007.  Inflation after having come down to 4 per cent is going above 5 per cent today.

What can we do? There is no magic wand to control or bring down the rate of inflation overnight as the people would like it to be.  There is always a time lag; steps taken now will have the desired effect a month, or two, or even three months later. Besides, even if the Government does not take any corrective measure, inflation will slow down when the supply situation improves.

Even though inflation is an apolitical phenomenon, it is loaded with serious political implications for the government in power and more so when elections are due.  The problem, however, is that the Government either tends to find scapegoats where none exist or takes inane measures which it too knows will not control inflation overnight.  The banning of future trading in certain agricultural products is one such example where there is no statistical evidence to suggest that the spurt in prices of agricultural products is because of it. Though future trading in agricultural products was banned last year, it has not lead to any fall in the prices of these products.

Similarly, banning of export of certain products or allowing freer import of certain agricultural products will show an impact after a few months. By that time the arrival of rabi crop in the market would have started dousing the inflationary pressures. Today, the international prices of essential commodities are higher than the domestic prices. Does it make any economic sense to import them to fight inflation?

Inflation in most of the developed countries is by and large due to money expansion with the Central Banks trying to control it by raising interest rates and restricting credit growth. For a central bankers inflation occurs when too much money is chasing too few goods. Thus, inflation can be brought under control by simply restricting growth of money supply.

Conscious of the inflationary pressures, the Reserve Bank of India (RBI) has restricted the growth of money supply, but the Finance Minister wants to lower interest rates to keep the growth rate from going down.  As it is, both the borrowing and lending interest rates are still high.  As a result credit offtake will be less and savings in terms of tenure deposits will increase. But it is unlikely that there will be any let up in the rate of inflation. However, any further increase in interest rates can adversely affect the growth rate. 

Now, it is for the Government, and not the RBI, to ensure that inflation is brought under control. This is so because the main reason for the increase in the price level is the mismatch between the demand and supply of essential commodities. This mismatch has not occurred overnight but has been gradually developing over the past few years.  For instance, the acreage under food crops has been shrinking, productivity of agricultural crops is stagnant; there is still no freer movement of agricultural products within the country.

In short, nothing has been done to increase the supply of essential commodities. The Government will have to take certain decisions now so that the prices of essential commodities remain relatively stable over a longer period of time.

Thus there is need for large investments in the agricultural sector and rural infrastructure.  This also calls for raising agricultural productivity by providing farmers with improved seeds and other inputs, timely credit, chain of cold storages, market information and so on.  In the past 50 years’ volumes have been written on this aspect, but the need is to implement them.  Can one ask if there is any blue print for this? 

Since agriculture requires massive investment it may not be possible for the government to do it alone. We know that outlays on agriculture have been going down.  For example, till the Fifth Plan, the outlay on the agricultural sector was 16.7 per cent, and it came down to 11.3 per cent in the Tenth Plan.

The Private sector will have to be roped in if we have to provide a big push to this sector. But to get the private sector to invest in a big way, we may need to change our land laws so as to allow contract farming on a big scale.  It may be a good idea to give waste lands to the private sector so that they can develop these to produce agricultural products.

Apart from increasing investments in the agricultural sector and improving rural infrastructure including supply chain, there is an urgent need to develop techniques to detect impending shortages much in advance, say at least eight to 10 months ahead before they assume alarming proportions.  In other words the Government must have a system in place to monitor production and availability of essential commodities on a daily basis, on both regional and national level with an inbuilt warning system to indicate an impending shortfall in supplies of certain commodities. This will help the Government to take timely measures to check the sneaking inflation. For a country like India, it should not be difficult to develop a customized software for this and put the system in place.

The simple point is that inflation or price rise cannot be checked over night, it can be done only by ensuring adequate regular supplies, or what economists call supply side management. Therefore, there is no point in sacrificing growth to control inflation. Instead, at this point of time the growth rate should be guarded while making efforts to control price rise. ---INFA 

(Copyright, India News and Feature Alliance)