From Business World of 16 August 2004.
This inflation
is an import
The finance
minister has made a number of reassuring statements about inflation in the last
fortnight. They would have reassured more if he had said how he would curb it.
In the absence of action one must be satisfied with his analysis.
Unfortunately
the analysis has also been shifting in the sand. The finance minister’s early
view was that there was a seasonal rise in prices of fruits and vegetables
which would be reversed as the monsoon progressed. This argument was repeated by
the Chief Economic Adviser; so it is safe to assume that the views of both had
a common provenance.
More recently,
the finance minister has widened the range of factors. To the seasonal factor
he has added the previous government’s slackness with money supply, whose
growth had gone up. He brought in the obvious cause, namely the inexorable rise
in oil prices. And then he added China, which is constructing stadia and
gymnasia like mad in preparation for the 2008 Olympic games, and buying up all
available steel for them.
The approach of
listing all possible factors counts as economics in India. But in making
policy, it is necessary to identify the critical factor. The required policies
differ considerably depending on the proximate causes; an omnibus approach can
result in overly diffuse, misdirected and unnecessary policy actions.
If the minister
is convinced that seasonal factors are the most important cause of the
inflation, he should do nothing at all. He should make confident statements
saying he will bring inflation down within seven weeks, and wait for prices to
fall.
That may have
been the right strategy given his early stance; but it would be disastrous if
the other factors he has brought in matter. At the moment it looks as if he
really believes the story about his predecessor having let money supply rip,
and is going to have the Reserve Bank do some monetary tightening. It does not
have all that much leeway. Thanks to the minister’s prudent handling of the
fisc, the Reserve Bank does not have government securities to unleash on the
market. It could issue more stabilization bonds. But that might raise interest
rates and reduce flow of credit to industry and services which are in the
middle of a boom. Manmohan Singh did that in 1995. The tightening went too far,
and a glorious industrial boom was brought to an end. The industrialists did
not thank him for it; nor did anybody else – except perhaps Mr Chidambaram, who
became the finance minister in the succeeding UDF government.
The important
fact is that retail and wholesale prices are behaving very differently. The
wholesale price index shows inflation to be around 7½%; cost-of-living indices
show it to be only about 3%. If he trusts the retail price indices, the finance
minister does not have to worry at all, for it is the cost of living that
matters to the consumer. And the purported seasonal rise in prices is a
non-starter; it is insignificant, and its reversal, if it happens, will make
little difference.
The minister
should recognize that the inflation is largely imported. He is right to
pinpoint the oil shortage and the China factor. The fact is that the world
commodity cycle has turned up, and the rising commodity prices are causing us
discomfort.
If he recognizes
this, the remedial action should be crystal clear: he must act on import
prices. There are two major ways of doing this. One is to reduce import duties.
They may be duties on oil and steel; but they do not have to be confined to
these commodities. It would be equally effective if import duties were reduced
on cereals, vegetable oils, sugar – consumer goods of concern to the common
man. The NDA government raised them to unconscionable heights to please its
trader and small industrialist lobby; it is high time they were brought down.
The other course
is to appreciate the Rupee. The Reserve Bank began to appreciate two years too
early; there was no reason for it in 2002. And it stopped doing it at the wrong
time, namely after the coming of the UPA government and the resulting outflow
of foreign capital. If the Rupee must be appreciated, there could not be a
better time than the present. But let it be done at one go, and not in a
creep.
