Waking up to
inflation
I have argued
for long that the conventional interpretation of India Shining – that India had
entered a golden period in which high investment would lead to continuing
increases in productivity and high growth would continue for decades – was
based on inadequate evidence and that the current boom was triggered off by
high liquidity and low interest rates fuelling both investment and consumption.
Fortuitously, the Economic Advisory Council to the Prime Minister addressed the
consumption part of this view in a report on the economic outlook that it put
out in August, and confirmed it. It found that personal loans had accounted for
half of the increase in bank credit in the three years up to 2005-06, and had
risen from 15 to 25 per cent of total credit. Seeing that bank credit had grown
by 32 per cent in 2005-06, it shared Reserve Bank’s preference for slower
credit growth; but it wanted more of the credit to go to investment and less to
consumption. Looking at prices the way officials do, it was of the view that
what inflationary pressure was there was confined to a handful of agricultural
commodities – mainly wheat and pulses – and could be dealt with by more liberal
imports immediately and higher productivity in the longer run. It noted the
sharp fall in share prices in May, but traced it to accentuated international
risk perceptions, and concluded that “the market appears to have adjusted,
stabilized, and come to a more-or-less neutral position” – in other words,
there was nothing to worry about.
Inflation
gathered pace, and others in the government got worried about it. So the EAC
made another report on inflation in December. It estimated that inflation then
was 5.7 per cent and would cross 6 per cent by March. It did not quite put it
that way, but it seemed to think that speculators were driving prices up and
that better information about crop prospects, more loudly disseminated, would
combat their disinformation. To its recommendation of duty-free imports of
wheat and pulses, it added reduction of import duties on nonferrous metals.
The EAC’s views
have been the basis of the anti-inflationary policies undertaken by the
government. Reserve Bank has raised interest rates modestly, slightly increased
the cash reserve ratio, and placed restrictions on loans against real estate.
The agricultural ministry has imported wheat duty-free. The finance ministry
has reduced duties on nonferrous metals. The Forward Markets Commission has banned
futures trading in principal pulses. So someone at the helm of economic affairs
in the government would carry the impression that it is following an active,
well-thought-out, well coordinated, comprehensive policy to keep inflation
under control.
Economic policy
is made in three steps. First, figures are read and projected. Second, policy
options are considered and chosen. Third, as the consequences unfold, policy
measures are adjusted. On facts, there are better and worse ways of reading
price statistics. My estimates of inflation, together with the likelihood
limits, are: food 6.5 (5-8), primary articles 6 (5-7), manufactures 4.2 (3.5-5),
overall 5 (4-6). Food price inflation went up sharply in the second half of
2005 when the poor kharif prospects became evident, and has tended upwards
throughout 2006. Manufactures price inflation actually came down in the second
half of 2005 and fell below 2 per cent by March 2006; it has been going up
since.
I think that one
reason why agricultural inflation is so high is the stop-go, discretionary
agricultural import policy. If the extremely high agricultural tariffs had been
brought down or eliminated and imports had been freely allowed, more would have
been imported and larger inventories been built up; that would have been far
more stabilizing than the syncopated imports by government. Manufacturing
inflation has been low because there are no import restrictions and tariffs are
generally low.
Reserve Bank can
never be relied on to take sufficient and timely deflationary action, both
because it would be too afraid of precipitating a crisis, and because with the
coming of credit cards and electronic payments, it is losing control on money
supply. The onus for anti-inflationary policy is entirely on the finance
minister. He should aim at a far greater fiscal correction than is planned
under long-term fiscal policy. My preference would be for restraining
expenditure; but his party men will, I am sure, have some bright ideas for
wasting money. So they would prefer a rise in taxes. Either way, policies
against inflation need to be more systemic, more macro and more fiscal.
