India is deeply intolerant of high inflation. It’s either because we have been blessed with very conservative policymakers or because the political elite knows that the electorate explodes in anger whenever inflation crosses the middle teens. That’s perhaps a comforting thought as the inflation rate moves towards double digits. History suggests that the chances of inflation running completely amok are quite low; but then history can be misleading.
The actual track record tells a more complicated story. India has never had to face the terror of hyperinflation. Look at Zimbabwe. The most recent estimate is that prices in that unfortunate African nation are rising at an annual rate of 66,000%. Prices change every day, and sometimes every hour. Its central bank introduced a 500-million-dollar note last month. It can be used to buy two loaves of bread,?Reuters had said in a 15 May report from Harare. Every citizen is a billionaire, but in terms of a currency that is worthless.
India has never had to face such insanity since 1801. The highest inflation that India has ever seen in the past two centuries is 53.8%, in the famine year of 1943. Amartya Sen has often written about the havoc wreaked by that inflation in his part of the country. Satyajit Ray captured the suffering in Ashani Sanket, a film he made in 1973. Those were terrible times, but nothing like what Germany faced in the early 1920s or what Zimbabwe has to deal with today.
Many other Asian countries have done far worse than India over the years. (The less said about hyperinflation-prone Latin America, the better.) Inflation in China reached 1,579% in 1947, when there was a civil war raging there. Japanese inflation peaked at 568% in 1945, the year of defeat and economic collapse. South Korea saw inflation shoot up to 210% in 1951, when it was at war with the communist North.
These episodes of runaway inflation are linked to political dislocations and war. So peace, political stability and credible governments do matter when it comes to keeping a lid on prices. But even if the extreme cases of inflation that have their roots in war are kept aside, India has a middling record in fighting the genie of rising prices. It has a far better long-term record than most other regional peers. India has spent about one out of every eight years with inflation about 20%. The likes of China, Indonesia, Korea, Myanmar and even Japan have done worse. But Asian economies such as Hong Kong, Malaysia and Singapore spent far less time struggling with 20%-plus inflation.
The ability to keep inflation under some sort of control is one part of India’s good economic record. The other part is the ability to stay clear of foreign defaults though, lest we forget, India has had three trysts with semi-defaults since it became an independent country. The government rescheduled foreign debt in 1958, 1969 and 1972.
The data used here is taken from a recent paper, by economists Carmen M. Reinhart and Kenneth Rogoff, on financial crises over the past eight centuries. They show that financial crises are a given in the world economy since the Middle Ages. “Serial default is a universal rite of passage through history for nearly all countries as they pass through the emerging market state of development,” they write. And add: “Episodes of high inflation and currency debasement are just as much a universal rite of passage as serial default.”
So, on the one hand, we have India’s reasonably good record in avoiding financial crises and hyperinflation. On the other hand, we have the iron law that high-growth economies tend to fall into trouble every now and then.
Which way will we go? A lot will depend on the policy response. Manmohan Singh is no stranger to episodes of high inflation. He was chief economic adviser to the Indira Gandhi government in the mid-1970s, when two years of 20%-plus inflation was attacked with the then-fashionable option of price controls. Then he was finance minister during the inflation spike in the mid- 1990s, when he and Reserve Bank of India governor C. Rangarajan pushed up interest rates to dizzying heights to bring inflation under control.
Now Singh is Prime Minister, and inflation is once again headed for double digits. His government has tried a mild version of the 1970s medicine — trade restrictions and moral suasion to hold the price line in commodities such as steel. But it is a matter of time before the 1990s medicine will have to be taken in a larger dose — higher interest rates.
There are several reasons why we should worry about the spike in the inflation rate. Inflation is a tax on the poor and long-term lenders. Also, as Reinhart and Rogoff show, “inflation crises and exchange rate crises travel hand-in-hand”. Inflation is already too high, though it is definitely not at economy-wrecking levels. But it’s best to be serious about the threat it poses.
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