Economic Highlights

New Delhi, 22 February 2007

Growth or Inflation?

PRICE RISE CAN’T BE CHECKED OVERNIGHT

By Dr. Vinod Mehta

If the choice is between growth and inflation, it makes sense to choose growth and ignore inflation, for inflation can be tackled through short-term measures like imports in weeks or months but if we lose growth momentum it will take years to get back that momentum.  It has taken almost fifty years to raise the growth rate by almost three times from almost three per cent to nine per cent today.

Inflation strains the budgets of the families with more or less fixed incomes and erodes their real incomes, while higher growth impacts the whole economy bringing in more revenues to the Government, leading to creation of more productive assets and more jobs.  An ideal situation is one where the growth rate is higher and the rate of inflation is modest.  In real life we seldom get such ideal situations. The Governments of the day has no option but to manage the situations with the options available to them at that particular point of time.

The rate of inflation which was about 5.5 per cent a month back is today 6.5 per cent and may go up to seven or 7.5 per cent. But the growth rate is more than nine per cent as of today and may even go up further.  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 months or even three months later.  And even if the Government does not take any corrective measure, inflation will slow down when the supply situation improves.

Inflation is apolitical phenomenon but loaded with serious political implications for the government in power and that too when the elections are due.  The trouble, however, is that the Government either tends to find scapegoats where none exist or takes inane measures which it knows fully well that it will not control inflation overnight.  The banning of future trading in certain agricultural products is one such example; there is no statistical evidence to show that the spurt in the prices of agricultural products is due to future trading in commodities.

Similarly, banning of export of milk powder or allowing freer import of certain agricultural products will show its impact after a few months and by that time the arrival of rabi crop in the market would have started dousing the inflationary pressures. The international prices of essential commodities are higher than the domestic prices as of today; therefore, does it make an economic sense to import them to fight inflation with such measures?

In most of the developed countries inflation is generally due to money expansion and the Central Banks try to control it by raising interest rates and restricting credit growth; for a central banker inflation occurs when too much money is chasing too few goods.  By restricting growth of money supply inflation can be brought under control.

The Reserve Bank of India has done precisely that in the past one month.  It has raised cash reserve ratio twice within a month.  Both the borrowing and lending interest rates have gone up.  As a result credit off take will be less and savings in terms of tenure deposits will increase. But there has been no let up in the rate of inflation.  However, any further increase in interest rates can adversely affect the growth rate. 

It is now for the Government, and not the RBI,  to ensure that inflation is brought under control.  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 for the past few years.  For instance, the acreage under foodcrops 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. And the supplies cannot be increased over night to control inflation.  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.

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

Since agriculture requires massive investment and it may not be possible for the Government alone to bring all the necessary investment. In fact, outlays on agriculture have been going down.  For instance, the outlay on the agricultural sector was 16.7% till the Fifth Plan but it came down to 11.3% in the Tenth Plan. Private sector will have to be roped in if we have to provide a big push to this sector.  To allow private sector to invest in a big way we may have to change our land laws to facilitate contract farming on a big scale.  It may be a good idea to give wastelands to the private sector so that they can develop these lands 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 at least eight to ten months 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 daily basis on a 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 sneaking inflation. It should not be difficult for a country like India to develop a customized software for this purpose and put the system in place.

The point is that inflation or price rise cannot be checked overnight; it can be checked by ensuring adequate regular supplies (or what economists call supply side management).  Therefore, there is no point in sacrificing growth to control inflation.  At this point of time growth rate should be guarded while making efforts to control the price rise.  The past experience shows that inflation automatically comes down the moment supplies improve.  The current inflation will also come down the moment rabi crops start coming to the mandis.---INFA

(Copyright, India News and Feature Alliance)