Supply crunch

Supply crunch
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First Published: Wed, May 02 2007. 12 39 AM IST
Updated: Wed, May 02 2007. 12 39 AM IST
One of the many things to envy about the Chinese economy is its astonishing ability to notch up red-hot growth rates with relatively mild inflation. While consumer price inflation spurts to over 7% in India on the back of a 9% growth in gross domestic product (GDP), the Chinese retail price index is up 3.3% while GDP is growing over 11%.
Rating agency Moody’s is also aware of this flaw in the Indian economy. Its vice-president, Kristin Lindow, while drawing attention to signs of overheating in the economy, has pointed out that these are the outcome of a structural shortfall in the absorptive power of the economy.
That means the economy is not equipped to handle all the money coming in and, as a result, the prices of goods and services go up. Put another way, what Lindow is driving at is that the supply response from the economy is not fast enough, with bottlenecks in infrastructure and in the expansion of productive capacity holding up growth.
So far, much of the discussion about inflation and the means to tame it have focused on either augmenting the supply of foodgrain, oilseeds and other such items on the one hand or on the other restraining demand.
Yet, little attention has been paid to the fact that accelerating the nation’s production capabilities results in the economy being able to cruise along at a higher speed with lower inflation. The Reserve Bank of India (RBI), when it hiked the cash reserve ratio in December 2006, said that “expansion of capacity is under way but the realization could be constrained over the next two years.” That is the reason the central bank is forced to apply the brakes with growth at 9%.
In contrast, the Chinese government has been busy building highways, ports, airports and even railways—the train to Lhasa is an example—well before there is an immediate need for them. By staying ahead of the curve, they have been able to ensure that infrastructural bottlenecks do not hamper growth. True, the Chinese system also allows uneconomic units to continue operating long after they have become unviable—the government, for example, has been trying to shut down uneconomic steel mills. But we can at least emulate what China has done in infrastructure.
In contrast, consider what RBI had to say about infrastructure in its recent monetary policy statement: “Infrastructural bottlenecks are emerging as the single most important constraint on the Indian economy. Rapid growth in demand for infrastructure, with a less than proportionate supply response in the prevailing investment climate, has resulted in stretching capacity utilization in electricity generation, roads, ports and major airports to overheating.”
The RBI statement points out that in the power sector, actual capacity addition has been less than 57% of the targeted level, taking the peak electricity deficit to an eight- year high. Capacity addition in roads and highways has been delayed over the last two years. Seaports are operating at close to full capacity utilization. Capacity constraints at the Mumbai and Delhi airports have forced restrictions on the number of flights that can be operated during peak hours in these airports.
China, too, has faced a similar situation in the past. In the late eighties, the first wave of reforms and foreign direct investment led to GDP growth in China accelerating to double digits, but inflation climbed as high as 18% in 1988. By 1990, inflation had been brought down, but growth too slumped to less than 4%. China has learnt the right lessons from that experience and there’s no reason why we shouldn’t. Instead of calling for higher interest rates to curtail inflation, it’s high time the government addressed the supply side of the equation.
Should India emulate China in infrastructure? Write to us at views@livemint.com
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First Published: Wed, May 02 2007. 12 39 AM IST
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