FROM BUSINESS WORLD OF 19 FEBRUARY 2007
Looking ahead,
realistically
A fortnight ago,
I wrote about inflation, which is beginning to engage the government. The
official view is that the inflation is microeconomic and can be tackled by
commodity-specific policies such as exports and ban on forward trading. Such a
view can almost always be confirmed, because rates of inflation invariably vary
across commodities; it is always possible to pick commodities whose prices are
going up faster. However, differences in the rates of commodity-specific
inflation do not prove it to be commodity-specific; for that, the trends have
to vary across commodities. If I look at the figures in that fashion, I find
that industrial inflation has been going up since March 2006. There was some
doubt about inflation in primary commodities, which came down year-on-year last
July and August. But the subsequent figures confirm that agricultural prices
too have been going up since March. So I am pretty clear that the primary
causes of inflation are macro.
The Prime
Minister’s Economic Advisory Council claimed that the current boom was
consumption-led; the evidence it relied on was the rising share of personal
loans in bank credit. This is a partial view. If one looks at all sources and
uses of finance, enterprises were highly liquid at the beginning of the boom in
2002 and were not borrowing from banks; so, much against their past prejudices
and traditions, banks started giving housing loans to individuals. If one looks
at GDP growth, investment has been growing at over 15 per cent a year since
2002, whilst the growth of private consumption has been of the order of 5-7 per
cent. This is also borne out by the fact that the share of investment in GDP
has gone up. The EAC may argue that investment includes housing; but it cannot
argue that housing is investment for estimation of GDP and consumption when one
looks at bank credit. Houses are durable assets, and spending on them is
investment. This confirms my belief that the boom is investment-driven – and
that the recent rise in inflation is a macro phenomenon, and signifies that the
economy is overheating.
One reason, as
last week’s Economist pointed out,
why the boom did not run into supply bottlenecks earlier, is imports: foreign
trade is far more open today than in earlier times, so excess demand spilled
out into imports. That in earlier times would have ended up in a balance of
payments crisis. That has not happened because of increasing capital inflows. But
the inflows are more of portfolio than of direct investment; they are therefore
less embedded in the economy, and can run out easily.
