Indian inflation is running high for the last couple of years. Tight liquidity, nominally high interest rates and hawkish policy stance have slowed its pace, but inflation is not yet in the comfort zone that Reserve Bank of India (RBI) would like it to be in.
The classical response on managing inflation is to raise rates, tighten liquidity and lower aggregate demand. Drop in demand brings down prices due to which growth suffers. In an emerging economy like India, low growth has significant social impact: unemployment increases as enough jobs are not created; transition of people from below poverty line to above poverty line reduces and creates social discontent; supply gets reduced on account of tight monetary policy. In short, the classical response curbs aggregate demand for a short time; limited supply and aspiring population together bid up prices to a higher level to raise inflation at a future date. Extraordinarily over-priced real estate in Mumbai explains this phenomena well: limited supply (not necessary due to tight monetary policy alone) keeps Mumbai real estate prices at astronomical levels year after year.
For a supply-constrained economy like India, maybe the option of lowering interest rates, providing adequate liquidity and speedier execution on ground to create enough supply to meet demand is a better way to tackle inflation on a permanent basis.
Operation flood, which made India the largest producer of milk in the world, is an example of how adequate supply can be created to meet demand and lower prices on a permanent basis. What happened in operation flood is beyond the realms of classical economy. Milk supply was created in response to demand in the real world rather than through financial incentives.
Textile upgradation fund (TUF) is another example of how adequate supply can be created to meet demand and lower prices on a permanent basis. TUF was launched in early 1999 to provide concessional rate of finance for the modernization of the Indian textile industry. It covered all aspects of the industry—from spinning, ginning, pressing, weaving and fabric processing, among others. It specified technology standards to bring in the right kind of modernization. Various banks and financial institutions were appointed to reach out to all parts of the industry across the country. The ministry of textiles extended TUF over the 11th and 12th five-year plans to provide continuity and support long-term planning. TUF disbursed Rs.1.7 trillion from 1 April 1999 to 31 March 2009 to 24,685 applicants. It is estimated that by June 2010, TUF disbursements reached about Rs.2.08 trillion.
The effects of TUF on capacity creation in the textiles industry are impressive. The output of the industry has increased from 2.808 million kg of spun yarn in 1999 to 6.233 million kg in 2011. Fabric production has increased from 35.44 million sq. m in 1999 to 60.996 million sq. m in 2011. Exports have jumped from $9.76 billion at 2.9% of global textiles exports in 1999 to $26.8 billion dollar at 4% of global textiles export in 2011.
Lower level of capacity utilization in 2011 versus 1999 suggests there is room for higher numbers in years to come.
The domestic textiles market has expanded to reach $77 billion in 2010. It contributes to about 12% of exports, 14% of industrial production, 4% of gross domestic product (GDP) and provides employment to 35 million people. It is expected that the Indian textile industry is likely to grow at a faster pace in the coming years as all the investments in capacity creation start bearing fruit. I don’t have a definitive study of price behaviour of textile products but the anecdotal experience does suggest that apparel inflation at the consumer level is lagging overall inflation.
TUF demonstrates that selective supply creation is possible in India by providing targeted credit, interest rate subvention and long-term funding. Certainly many other factors such as relative depreciation of rupee versus renminbi also contributed to capacity creation in the textile industry. Notwithstanding supportive factors which increased the magnitude of supply creation in the textile sector, the direction of supply creation was established by TUF, which shows that a little bit of effort along with a little bit of luck can help create adequate supply across basic products that aspiring Indians require.
TUF has reasonably managed the issue of inflation in kapda (clothes), maybe it is worth doing similar things for roti (food) and makan (housing).
Nilesh Shah is director, Axis Direct.