It’s also possible to argue the opposite, not because of inflation per se, but because you have a real financial sector problem. If you see the way the Sensex (the benchmark index of the Bombay Stock Exchange) was going and then it broke apart, purely due to speculative pressures, this is not explicable in any objective terms. One is now borrowing only to invest in the stock market long term, practically tax-free; last year’s return (on the stock market) in dollar terms, from budget to budget, was 70%. Despite all the obstacles, the kind of escalation in asset prices that we see does pose a kind of danger. The most important thing about the financial system is that a crisis happens particularly when times are good. And when it happens, it affects the real economy. In real economy terms, the US slowdown will not affect us, but if you look at its implication for the financial markets, it is vital. The profit margins of many corporates have been swelled by other income. Every company is creating its own mutual fund. Once that bubble gets pricked, the real economy is bound to be affected. Steel or construction could get affected because there’s no money. There’s a linkage, a triangular relationship between the real economy and the financial economy, and the external economy. So, that symbolic gesture could lead to more bubbles.
How serious is the inflation threat?
It was believed in the beginning of the fiscal that it would be 5%. From 4%, with the oil price hike, it could end up as 4.8%. We had 6% last year. We also have supply-side remedies and growth is good. I don’t see it as a threat really, unless we make any mistake.
Capital inflows, too, are still high…
In an environment of an appreciating rupee, foreign funds add another dimension to the problem. At the microlevels, if you are managing this economy, you can use the tolls of interest rates, exchange rate, etc. From the macroview, the real question we have to ask is why do we have this situation and why are we not managing this economy in a better way.
If money is coming in, in this way, we have to find a way of either making it more expensive, less remunerative, less sure, (through) more holding restraints, capital gains taxes, measures that are not capital controls per se, but ways to reduce the attractiveness of this route, which is without any risk.
The Tobin tax (a tax on currency trades across borders)?
The Tobin tax won’t work because it creates multiple exchange rates.
I agree there are no easy answers, except that I would closely watch why is so much money flowing into one segment of the financial markets. The only lesson is to take pre-emptive steps, to reduce the “exuberance”, which is rational at the moment, but will very soon cease to be if more and more people start borrowing abroad to invest here.
Are a high fiscal deficit and increased government spending a prerequisite for inclusive growth?
The fact remains that half of our upper middle class, especially in skilled categories, is raising its income by a minimum of 25%. That part is good. But on the other side, the unorganized sector, the wages are not increasing. So, there’s a real sense of disparity. If this means no wage growth for the poorer, no health, no housing, no education, it results in a lot of bad inequalities. So, a lot of this 300 million (population) is dependent on the government for education, health services, employment schemes.
But they are not necessarily getting it despite the higher allocation.