In the current popular mood, it seems appropriate to say that the government is handling inflation pretty much the same way in which it has handled Anna Hazare. Both are being treated as a problem without understanding the context in which these have become such a national issue. Corruption and inflation are perhaps two of the most enduring, you might even say, “staple issues” that the economy has faced. Why have they become such emotive issues at this juncture?
Also Read | Haseeb A. Drabu’s previous columns
The key to the issue and, of course, its resolution lie in appreciating and understanding the context; the changed structure of the economy in the case of inflation and the changed structure of civil society in the case of Hazare.
The structural break in civil society comes not only from a greater access to information courtesy the Right to Information Act and associated changes, but also the greater and speedier dissemination of information, courtesy the mass and social media. The factors of better technology and the increasing globalization of the country, as against the economy, are important enablers of a more, if not better informed civil society.
In the case of inflation, over the last two decades the structure of the economy, banking and financial markets has changed vastly. In fact, in the arena of financial markets, between 1991 and 2011, nothing is the same except the policy interventions of the Reserve Bank of India. Even as the style and to some extent the design of monetary policy might have changed, the substance of its policy interventions has remained the same. As such, their efficacy has been limited.
Instead of looking at inflation on a point to point basis as is being done currently, it might be better to look at it as a part of the big underlying trend that has been taking place globally over the last five to seven years. The current bout of inflation in India needs to be seen in the context of food prices having doubled, energy prices having tripled and metal prices having more than quadrupled in the last eight years.
At a macro level, analysts have observed that the prices of all important commodities, except oil, declined by 70% for over 100 years till 2002. From 2002 until now, this decline has been erased by a bigger price surge than what occurred during World War II. This break in trend is now being referred to as the “Great Paradigm Shift”.
India being a net importer of commodities, the impact of this adverse break in trend on domestic inflation is obviously going to be much stronger. Notice that, more than food prices, it is manufactured non-food products, core inflation, that has become the main driver of inflation.
The other big contributors to a trend break in inflation is the rising demand in emerging economies led by China who have a much higher intensity of commodity intensity in their gross domestic product. Further, there have been non-physical demand factors such as the growing financialization, and looser regulations—be it the repeal of Glass-Steagall Act in 1999-2000, or the Commodities Futures Modernization Act in 2004 that have contributed to the rise in trend rate of inflation.
The combined impact of all these factors appears to be far greater than the easing in interest rates by all major central banks, liquidity support, quantitative easing and aggressive credit expansion. These, of course, are factors and not the reason for the problem. Loose monetary policies may have facilitated, but have not generated the Great Paradigm Shift.
If this is indeed the underlying trend of inflation and its causes, then what will monetary policy action in India, baby or giant leaps, do to reverse or reduce its impact on domestic inflation? How does monetary policy address issues of structural breaks?
In response to the greater paradigm shift, there has to be a similar shift in policymaking, perhaps a public-private partnership in economic policymaking. For starters, more than the Five-year Plans, we need more direct and focused resource plans (physical not financial resources) where the government and the private sector work towards building the country’s narrow resource base.
It might be of interest to know that when the long and famous stagnation and structural retrogression of the Indian economy was “discovered” and intensely debated in the 1970s, the prevailing policy rates and reserve ration were exactly as they are now: in 1970, the cash reserve ratio (CRR) was 6%, the statutory liquidity ratio (SLR) was 26% and the bank rate was 6%. It is hard not to notice that at present CRR is 6%, SLR is 24% and bank rate is also 6%. Annual inflation in early 1970, barring the spike of 1974, was around 9%. Just to add to the list of similarities, don’t forget that the JP Movement was initiated in the 1970s to crescendo in 1974. Is it all coming together again?.
Haseeb A. Drabu is an economist, and writes on monetary and macroeconomic matters from the perspective of policy and practice. Comments are welcome at email@example.com