What to do about inflation

What to do about inflation

There has been a lot of discussion in the media about what the Reserve Bank of India (RBI) should be doing to tackle the inflationary pressures that are now so evident in the economy. Just a few days ago, the chairman of the Prime Minister’s economic advisory council had suggested that RBI should act quickly in tackling inflation, a clear sign of the anxiety that rising food prices are causing at the decision-making levels of government. The recent climbdown by the government on the sugar cane price ordinance will only exacerbate these pressures. Policymakers appear to be caught in a bind and there appear to be several reasons for this.

First, there is the concern that RBI may be able to do very little about inflation. Deena Khatkate has argued in a recent book, Money, Finance and Political Economy, that inflation in India arises from non-monetary factors, and inflation targeting as an operational strategy will not be able to address core inflation. We saw this happen in 2007 and 2008, when inflationary pressures were caused by rising commodity prices, and the government, yielding to public pressure, kept increasing interest rates with little effect on core inflation. Monetary policy changes work into the economy with a lag, and it is unlikely that raising interest rates will have any effect in the short to medium term on supply-side constraints.

Second, there is the larger question of the rolling back of the fiscal stimulus of last year. I had argued earlier that the fiscal stimulus package in India was very different from that in other countries, as it consisted of subsidies and giveaways for consumption—through the National Rural Employment Guarantee Scheme (NREGS) and other programmes—and that it would be difficult to roll back these grants. Given an extremely soft state and decision-making that yields at the slightest pressure, the packages for food, fuel subsidies and doles for idling are likely to remain.

Third, the pressures on the fiscal deficit continues, with poor revenue collections leading to all sorts of curbs on expenditure—even Plan expenditure is way below expectations, and the infrastructure initiatives are still only on paper. There is a scramble to meet the revenue deficit through small stake sales in public sector units—there is now no talk of better governance or transparency as a cause for disinvestment; it is purely a revenue generation exercise.

These problems will not go away easily and, given the structure of politics, will be addressed only incrementally, not frontally. This does not mean there are not other, meaningful, public policy opportunities that can be acted on. There is tiredness among policymakers, a “what can we do" attitude, which is perhaps making them miss out on several opportunities that have presented themselves.

Among the more important is the goods and services tax (GST) initiative. Now that the draft paper is available for discussion, it is important to take it forward to be implemented as quickly as possible and find ways of convincing some of the reluctant states. There is also an opportunity for pushing forward a lot of legislation on financial reforms— there is a need for managers of parliamentary affairs not to allow emotional matters such as sugar cane prices overwhelm the legislative agenda. The report of the Finance Commission is due and affords an opportunity for putting the finances of the states on an even keel once again—coupled with GST, there is a unique window of enabling the states to stand on their own feet.

Some of the social sector initiatives offer exciting prospects—the National Rural Health Mission is one such. Here is an opportunity to work with the states, to put the fear of god into implementation agencies and to provide affordable healthcare solutions for the majority of the population. The constant review of NREGS is good sign that there is a sincere effort to make it efficient and productive. There are healthy signals coming out of the human resource development ministry—one hopes for some serious improvements in primary, secondary as well as tertiary education deliveries and standards.

Finally, the real solution for inflationary pressures caused by supply shortages is to have a strategy for removing supply-side constraints. We have heard repeated articulation of the need to increase the size of the manufacturing sector as well as to revitalize agriculture. However, there appears to be little in the nature of strategy or programme to enable this to happen. This is surprising; given the reports of the knowledge commission, the manufacturing competitiveness commission as well as the reports on agriculture that are available with the government, it is really time for action on these. Otherwise, these supply-caused shocks will become a regular feature of our economy, and we will be moving from food price inflation to commodity price-based inflation to huge current account imbalances.

An important feature of economic policy-making in China appears to be the ability to seize windows of opportunity. This requires goals to be set, strategies in place and to wait for opportunities. With a healthy economy, we have several opportunities—it is for us to seize them.

S. Narayan, a senior research fellow at the Institute of South Asian Studies, Singapore, is a former finance secretary. We welcome your comments at policytrack@livemint.com