Inflation in India has been at ugly levels for a good many months now. Prolonged inflation has started pinching the country. After being within acceptable limits for about ten plus years since the middle of 1990s [which roughly coincides with a significant part of tenure of the NDA government and the first half of the first term of the current UPA government] it has gone topsy-turvy.
So what do the policy makers do in such a situation? In the classical macro-economics paradigm one has the monetary policy and the fiscal policy as the two levers to control inflation. The fiscal policy inevitably has a lag effect from the time of policy pronouncement to the time of visible / measurable impact on the economy.
Therefore, the short term solution seekers that we are, the onus is invariably on the RBI to tweak the monetary policy.
That is what has happened. The RBI has increased the repo rate 11 times since April 2010 in an attempt to mop up the surplus funds in the economy and hence reduce demand side inflationary pressures. But honestly, this will just not work. Why? Simply because, it has not worked yet. Increased bank rate is being unable to reduce money supply on two counts. Foremost, India is already a part of a global network. We just cannot create an environment here which is in variance with that of the major global economies. Having an interest rate at 10% or thereabouts with a stable rupee against dollar creates arbitrage opportunity for international debt/fixed income funds to come into the country. Secondly, the black money in the system [which has increased rapidly in the last decade] cannot easily find its way into the banking system and will not respond to the lure of higher fixed deposit rates. So higher interest rates are neither reducing corporate borrowings/spending nor are they reducing consumer spending.
So what can we do? We will need to go deeper into the root of the matter. We will need to do our pareto analysis and use a mix of innovative and tough solutions that hits the inflation on its head. We can target the three areas: Firstly about reducing money supply, foremost we need to do something about getting any unproductive black money [in India all money of that colour is not unproductive/inflationary] into the system – then we can tinker with interest rates and expect other monetary policy tools to start behaving. Maybe use technology / plastic – ban cash transactions above a particular amount say Rs. 1 lakh. Now everyone in the country has mobile phone and ATM cards – so the poor will not be affected if we have electronic / plastic transactions. This will straight away hit corporate / HNI black money transaction. Either black with turn white [read productive] or will flee to Swiss banks. Both ways – it will help tackle inflation.
Second, reduce consumption. One of the biggest drivers of inflation in our economy is fuel prices. Incentivize public transport and dis-incentivize private transport. Having comfortable Mass Rapid Transport Systems, are good but they will take 20 years to give results. So also will proliferation of non-fossil fuel sources. Till that time, we need to have a mechanism to reduce superfluous fuel consumption which does not have direct bearing on industrial production. This reminds of the strategy of one country or city [don’t recollect in the late 80s or mid 90s] which had cars which had to choose one of the seven colours prescribed. Cars of one colour were off the road everyday!! Reminds us to emergency times? But in tough times, we need tough decisions – short term politically correct decisions maybe difficult to find. Am sure with a nation-wide contest we can get more elegant ideas in a jiffy. Third, increase supply – especially of agricultural products. It is extremely difficult to reduce prices of essential commodities through reduction of money supply. These prices are linked to global prices, so the only thing we can do is increase production. Stop conversion of agricultural land for building purposes. Distribute hybrid seeds through PDS systems. And most importantly Lower interest rates [not increase]. Note any economy with a high interest rate for 2-3 years will start sliding into stagflation [the sorry state of low growth and high inflation rate]. Indian macro indicators of lower growth and higher inflation indicate that we are about to enter the amber zone. I cannot comprehend that the RBI and Fin Ministry top bosses have not noticed this yet
What more can we do? Mitigate the impact of inflation. Through inclusive growth, nothing else. If income distribution is efficient the citizens will be better off, even if there are inflationary pressure due the reasons relating to global economic / production cycles, as long as we have a healthy real effective growth rate [that is that nominal growth less inflation upwards of 7% - which we have now]. The crux then, boils down to keeping the bottom of the pyramid happy. Distribution of Rs. 2/kg is not exactly sustainable income re-distribution, as that strategy is incentivizing lower agricultural productivity and increasing inflationary pressures both from the demand and supply sides. True, there have been lot of well-intended initiatives in this direction - micro-finance, SHGs, NREGP. We need to focus on better execution and better metric. Minimize leakages of funds meant for bottom of the pyramid to the middle class / upper classes. Intensify innovative-tough solutions that hit the head of the problems in this sector. Focus on capacity building at the bottom of the pyramid Рso that this sector can be the global workforce. The IT labourers story is pass̩ now [we will start seeing revenues being shifted to other East Asian countries now], because we are getting expensive and less competitive. So we must create other skills globally acceptable from the quality perspective and competitive from the cost perspective. This will chug the growth engine for another 10 years and more importantly will create real inclusive growth.
Bhubaneshwar
August 23, 2011
So what do the policy makers do in such a situation? In the classical macro-economics paradigm one has the monetary policy and the fiscal policy as the two levers to control inflation. The fiscal policy inevitably has a lag effect from the time of policy pronouncement to the time of visible / measurable impact on the economy.
Therefore, the short term solution seekers that we are, the onus is invariably on the RBI to tweak the monetary policy.
That is what has happened. The RBI has increased the repo rate 11 times since April 2010 in an attempt to mop up the surplus funds in the economy and hence reduce demand side inflationary pressures. But honestly, this will just not work. Why? Simply because, it has not worked yet. Increased bank rate is being unable to reduce money supply on two counts. Foremost, India is already a part of a global network. We just cannot create an environment here which is in variance with that of the major global economies. Having an interest rate at 10% or thereabouts with a stable rupee against dollar creates arbitrage opportunity for international debt/fixed income funds to come into the country. Secondly, the black money in the system [which has increased rapidly in the last decade] cannot easily find its way into the banking system and will not respond to the lure of higher fixed deposit rates. So higher interest rates are neither reducing corporate borrowings/spending nor are they reducing consumer spending.
So what can we do? We will need to go deeper into the root of the matter. We will need to do our pareto analysis and use a mix of innovative and tough solutions that hits the inflation on its head. We can target the three areas: Firstly about reducing money supply, foremost we need to do something about getting any unproductive black money [in India all money of that colour is not unproductive/inflationary] into the system – then we can tinker with interest rates and expect other monetary policy tools to start behaving. Maybe use technology / plastic – ban cash transactions above a particular amount say Rs. 1 lakh. Now everyone in the country has mobile phone and ATM cards – so the poor will not be affected if we have electronic / plastic transactions. This will straight away hit corporate / HNI black money transaction. Either black with turn white [read productive] or will flee to Swiss banks. Both ways – it will help tackle inflation.
Second, reduce consumption. One of the biggest drivers of inflation in our economy is fuel prices. Incentivize public transport and dis-incentivize private transport. Having comfortable Mass Rapid Transport Systems, are good but they will take 20 years to give results. So also will proliferation of non-fossil fuel sources. Till that time, we need to have a mechanism to reduce superfluous fuel consumption which does not have direct bearing on industrial production. This reminds of the strategy of one country or city [don’t recollect in the late 80s or mid 90s] which had cars which had to choose one of the seven colours prescribed. Cars of one colour were off the road everyday!! Reminds us to emergency times? But in tough times, we need tough decisions – short term politically correct decisions maybe difficult to find. Am sure with a nation-wide contest we can get more elegant ideas in a jiffy. Third, increase supply – especially of agricultural products. It is extremely difficult to reduce prices of essential commodities through reduction of money supply. These prices are linked to global prices, so the only thing we can do is increase production. Stop conversion of agricultural land for building purposes. Distribute hybrid seeds through PDS systems. And most importantly Lower interest rates [not increase]. Note any economy with a high interest rate for 2-3 years will start sliding into stagflation [the sorry state of low growth and high inflation rate]. Indian macro indicators of lower growth and higher inflation indicate that we are about to enter the amber zone. I cannot comprehend that the RBI and Fin Ministry top bosses have not noticed this yet
What more can we do? Mitigate the impact of inflation. Through inclusive growth, nothing else. If income distribution is efficient the citizens will be better off, even if there are inflationary pressure due the reasons relating to global economic / production cycles, as long as we have a healthy real effective growth rate [that is that nominal growth less inflation upwards of 7% - which we have now]. The crux then, boils down to keeping the bottom of the pyramid happy. Distribution of Rs. 2/kg is not exactly sustainable income re-distribution, as that strategy is incentivizing lower agricultural productivity and increasing inflationary pressures both from the demand and supply sides. True, there have been lot of well-intended initiatives in this direction - micro-finance, SHGs, NREGP. We need to focus on better execution and better metric. Minimize leakages of funds meant for bottom of the pyramid to the middle class / upper classes. Intensify innovative-tough solutions that hit the head of the problems in this sector. Focus on capacity building at the bottom of the pyramid Рso that this sector can be the global workforce. The IT labourers story is pass̩ now [we will start seeing revenues being shifted to other East Asian countries now], because we are getting expensive and less competitive. So we must create other skills globally acceptable from the quality perspective and competitive from the cost perspective. This will chug the growth engine for another 10 years and more importantly will create real inclusive growth.
Bhubaneshwar
August 23, 2011
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