The Reserve Bank of India conducts regular survey of households, to gauge their future inflation expectations. The RBI’s mandate is first and foremost to protect the value of money, which means maintaining price stability. That requires it to make an informed guess about what the public is thinking about price movement. For the past five years the survey consistently shows that households expect inflation to be above 12 per cent. This inflationary angst is considerably above what used to be the case between 2000 and 2007, when expectations were much lower. The actual inflation rate in early 2002 was barely 1 per cent.
This five-year angst also partly explains why there was a steep increase in the demand for gold. Gold is an instinctive hedge against inflation, and gold imports shot up to $60 billion last year, causing the current account deficit to widen dangerously, and the rupee crashed from 54 to 67 to the dollar last year.
This caused a near panic reaction from the RBI and the government, as import duty was increased to 10 per cent, and gold imports came down sharply. But inflation has continued to remain close to double digits. This is the macroeconomic backdrop to the presentation of the Union Budget later this week.
High inflation, made worse by surging crude oil prices internationally, and looming drought like conditions caused by a delayed monsoon.To add to this fire there has been a hike in the railway fares (steep by historic standards), and upward adjustment of prices of petrol, diesel and cooking gas cylinders. Food prices are on an upward path, with cereal inflation already clocking 13 per cent.
Onion prices have hit the headlines. The food inflation phenomenon is ironic, because we have had record production in food-grains last year. Even onion production at 19 million tonnes is at a five year peak. The granaries of the Food Corporation of India are overflowing with more than 60 million tonnes in stock. Why are we then unable to tame the inflation monster? Food inflation has a way of spiralling into wage inflation, which can hurt investment sentiment. High, persistent and volatile inflation is an enemy of sustained economic growth.
This is a uniquely Indian problem. The European Central Bank recently cut interest rates down to below zero. This era of negative interest rates is completely uncharted territory. The reason for such drastic action is because the ECB is fearful of deflation in the European Union.
In Japan too, the monetary authorities are struggling to inject some inflation. Prime Minister Shinzo Abe won his election on his promise to bring back inflation. The US too is trying to avoid low inflation. Hence India’s high inflation rate, and consequently high interest rates stand out. It is not surprising that foreign money is freely flowing into our debt market, since it earns a high return on our government bonds without any risk.
Inflation management and control in India needs the cooperation of both monetary and fiscal authorities. During Governor Subbarao’s regime, he rarely lost an opportunity to remind, and even chastise Delhi for its fiscal recklessness, which often rendered monetary medicine useless.
The stimulus injected in the wake of the global financial crisis in 2008 and 2009 was never fully withdrawn. The quantum of subsidies during UPA’s entire tenure went up from 1.6 to 2.6 per cent of GDP. Welfare spending also expanded substantially on health, education and rural employment guarantee.
The rights based approach of development gave a high spending bias to the fiscal stance. It is as if all the dividend earned on high economic growth between 2003 and 2008 was squandered in a consumption stimulus.
As a consequence perhaps, rural wages and purchasing power rose, reflecting decline in rural poverty, but so did the general inflation level and inflation expectations. During UPA-2 the misguided concept of a “new normal” for higher inflation of 8 or even 10 percent gained currency.
In the past three years all these expansionary chickens came home to roost. Capital spending dipped, and manufacturing growth ground to a halt, for two consecutive years. Investment optimism faltered, and died. As the consumption impetus lost steam, GDP lost both consumption and investment drivers,and hence the growth rate declined steadily.
The delays in clearances and approvals, made matters much worse. We are now at a stage dangerously close to a stagflationary condition.Growth is tepid, and inflation is roaring. The UPA’s last interim budget showed that the deficit target for the previous fiscal had been achieved. But this was done by sharply reducing capital spending (spelling doom for future growth), and by postponing certain committed spending. Both of these are questionable tactics.
The tax collection growth target was set at 19 percent. This was too heroic, and actual collection growth was barely 9 percent, missing the target by a mile. Hence it is a given that the fiscal target of 4.1 percent for this fiscal will become at least 4.5, since some obligations have spilled over from the previous budget. The RBI is not going to let go of its hawkish stance, hence interest rates will remain high. That implies high interest payment commitments from the government. The NDA government would however do well to restrict itself to fiscal deficit of 4.5 per cent, since any further expansionary fiscal stance is bound to be inflationary.
Given this messy inheritance, is there much fiscal manoeuvring room for the Modi government? Apparently not. It faces the triple balancing task of lowering inflation, achieving fiscal consolidation and providing growth impetus. Factors such as the Iraq crisis and El Nino were not considered when the promise of “achche din” was made.
Thankfully no date was set for the commencement of “achche din”, so we can wait till next year. Since inflation control should remain as the topmost priority, the budget should not introduce any further price hikes. This means no new taxes or surcharges, restricting the increase in minimum support prices, and a cap on revenue spending. Fiscal consolidation should be pursued only by focusing on non-tax resources such as disinvestment and spectrum auctions. The Prime Minister promised doses of bitter medicine. We can only hope that they are homeopathic doses, with potent impact on bringing inflation sharply down.
Modi's challenges
- A failed monsoon might stoke inflationary pressures as agriculture sector which accounts for just 18 per cent of GDP, employs 60 per cent work force and a majority of farmers bank entirely on rains for irrigation.
- Crisis in Iraq, the second largest oil producer within OPEC, might cause crude oil prices to flare up. India is keeping its fingers crossed since the civil war could spread to other parts of West Asia from where the country gets huge amount of foreign exchange as remittances.
- Options
- Contain persistently high inflation
- Revive an economy which is caught up in the worst slowdown since 1980s
- Stabilise the volatile rupee.
- Simplify the tax laws as promised in BJP poll manifesto.
(Dr. Ajit Ranade is an economist, political analyst and serves on board of various national and international companies.)
