27 November 2013, 03:23 PM IST
To tame runaway inflation , India needs political solutions , not just monetary tightening
RBI governor Raghuram Rajan cannot bring inflation down. Only politics can. The sooner politicians , policymakers and analysts realise this, the sooner we will have realistic solutions.
Inflation has three different drivers . One is the large fiscal deficit, which creates demand for goods and services in excess of the supply. Another is steady increase in fuel prices as part of a programme of gradual decontrol in a context of volatile global energy prices and a weak rupee . And the third is a steady increase in the demand for fruit and vegetables and a range of protein foods such as lentils, milk, meat, fish and eggs. To squeeze any of these inflation drivers, you need good politics.
Finance minister P Chidambaram has said that he would hold the deficit down below 4.8% of GDP. And his determination is clear and credible. But this is not enough. This is because the effect of the fiscal deficit on inflation is not straightforward and depends on the composition of government spending and the level of investment by the private sector.
The fiscal deficit lays a claim on the non-government sector's savings . If this claim is less than what the private sector has to spare after meeting its own investment, there is no problem. But when the deficit is large and so, therefore, is the draft on private savings, the credit system allows both the government and the private sector to meet their expenditure targets in nominal terms, but excess demand would create inflation , reducing effective expenditure.
If the government uses its borrowings to invest, that would spur growth. If the government uses its borrowings to fund consumption, which is what happens when money is spent on subsidies, it would just appropriate private savings and direct them away from capital formation , whether by itself or by the private sector. This depresses growth.
Costly Fuel Beneficial
It matters whether Chidambaram would meet his deficit reduction target by slashing expenditure on consumption or capital formation. Politics would determine if the government dares to cut fuel and fertiliser subsidies and spend more on roads and bridges and new townships, as, for example, along the Delhi-Mumbai Industrial Corridor.
Fuel price decontrol is necessary to reduce the fiscal deficit. At the same time, it directly and indirectly feeds inflation, although Kirit Parikh's simulations suggest that the net effect on the overall price index of reducing excess demand by controlling the fiscal deficit would outweigh the impact of allowing fuel prices to go up.
This is not easy to explain and communicate to ordinary voters. It takes a lot of political skill and credibility to convince people that raising diesel prices would actually make their overall consumption basket more affordable. It would take even more courage to decontrol fuel marketing , breaking up the cosy monopoly of public sector fuel marketing companies and throwing the retail business to stand-alone retainers with no refining stake.
The biggest contributor to inflation is food. Of this, inflation in cereals is entirely the government's fault. It sits on the largest hoard of grain in India's history and lacks the administrative courage and wherewithal to sell large chunks of its stocks across the country in small lots to squeeze cereal inflation out of the system altogether. It takes politics to either sack the incompetent food minister or force him to get his ministry , petrified into inaction by obsessive fear of being accused of selling grain cheap and causing loss to the exchequer, to act.
The only way to combat inflation in protein foods and fruit and vegetables is to step up output. That is lots of complex politics.
Changing rural economy
Ongoing structural transformation of the rural economy — only 49% of India's workforce is now engaged in agriculture , according to the National Sample Survey — has seen real wages rise steadily in rural India. This has increased broad-based demand for superior foods and increased their cost of production. The pain that urban consumers feel is more than offset by the material gain to the rural poor, whose living standards are going up. Only good politics can make this collective improvement to social welfare palatable to those made worse off in urban centres. More to the point, good politics alone can increase production.
Power-Hungry
For farmers to benefit from higher prices in consumption centres, the current dominance of middlemen in the farm supply chain must go. This is high-voltage politics, tougher than making power flow along the lines that have been drawn, under the Rural Electrification Programme , to 80% of all villages, to create a cold chain. For this, state monopoly in coal has to be scrapped. Power distribution must become sustainable. That means ending patronage of power theft and giveaways.
Right now, it is possible that hoarding plays part in fuelling some prices like that of onions. Combating that, too, is politics. Move over, Raghuram Rajan.
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