Posted by: qmaxim | October 18, 2014

Growth or inflation? – dilemma for India

It has been 5 months since PM Modi lead NDA (National democratic alliance ) took over the the central government in New Delhi. Among the many issues new government had to tackle urgently was the record low growth rate ( 4.4% GDP growth – a 20 year low) and persistent double digit inflation.

One of the debates raging in the govt. circles and the media is – which of these two issues have to be tackled first. Until now opinion of RBI (Reserve bank of India) governor – Dr Raguram Rajan ( a distinguished ex- IMF chief economist) has prevailed.

He has been of the view that inflation has to be tackled first- and unless inflation is brought under control growth can’t be ramped up. In order to ‘fight’ inflation one of the tools employed by RBI is keeping the lending rates high. Governor Rajan has resisted pressure to reduce the rates so far. This rate has bearing on lending rates of banks – this makes loans taken for purchasing household goods, housing, businesses etc, costlier.

I am of the view that focus should be on increasing growth rather than ‘fighting’ inflation. Here is why.

Firstly, I think inflation number has large errors –an important management principle is – what can’t be measured properly can’t be controlled. Govt. periodically publishes several inflation numbers – retail inflation, headline inflation and several others.RBI monetary policy depends on these numbers.
There is a high level of variation from state to state, region to region, urban areas to rural areas and even between various suburbs of the cities. In fact, as reported in the press, the prices of some of the commonly used items in the consumption centers is 2-3 times of what it is in the producing areas. Some of the reasons for this large variation is – inefficient markets, lack of cold storage, inefficient supply chain, large number of agents/ speculators, many small pop and mom (kirana ) shops, unequal taxation in various states, etc. This is not going to change any time soon. The inflation number RBI relies on to make decisions is a composite number- with weightage given for various items. Thus situation is unlike that of developed counties -with their well developed supply chains, efficient markets and availability of reliable data going back decades. Even in the US many states publish their inflation and other numbers – & Federal Reserve takes this information into account while making policy. With greatly improved telecommunication/ IT systems at present it should be possible to develop a better data gathering & reporting mechanism in India.

Secondly, question to ask is – is it desirable to control inflation? No doubt, low inflation is good for consumers. But, in India large proportion of the people particularly in the rural areas are dependent on agriculture – higher prices of their produce is obviously better for them. Over the years, prices of many food items have been gyrating wildly – for example- price of onions have been between Rs 8 to 80 in the last one year. In the good years people in the rural area feel suddenly wealthy and there is boom in sale of goods and services. And in bad years – when prices are at the bottom- many commit suicide. Thus the govt. has to balance the price expectation of the two communities. Thus, too low a inflation is not good for everyone.

Thirdly, question to ask is – is it possible to tackle inflation by changing bank rates alone- I don’t think so. As I said before, calculation of inflation numbers needs revisiting. India differs significantly from developed economies in most ways. India is largely cash based economy. Most of the population even now does not have bank account- PM Modi has recently launched a scheme to change this situation. Minuscule part of the population owns stocks or bonds. Very small part of the population pays income tax- and agriculture income is totally tax free. Also, in many cases, prices are distorted as govt. decides reserve procurement price of many food items and supplies to certain consumers at dirt cheap prices. For example, rice is purchased at Rs 22 / kg, supplied to ration shops at Rs 1 /kg and open market price is Rs 50. Nobody is going to lower price below this base level whatever the bank lending rate may be. Many years of the growth can come from modernizing India’s moribund infrastructure – this is unlike developed economies where growth comes mainly from consumption. All these make well known laws of economics (applicable to developed countries ) of doubtful validity to India.

Fourth and final – one has to question the hypothesis that low inflation has to happen before growth. During the previous NDA govt., (1999-2004) growth was about 8% but inflation was under tight control, but RBI lending rates were at record low. Last week,wholesale inflation suddenly touched 5 year low – with no change in RBI rates. This was mainly due to falling oil prices, seasonal price fluctuations, expectation of bumper crops, administrative price control measures taken by the govt., & responsive governance. These along some other measures such as much delayed enactment of Goods and Services Tax (GST) legislation will go long way in managing inflation and accelerating growth.Another aspect to tackle is opening up and computerization of agricultural markets (Mandis) – which will lead to deepening of the markets and would make them more efficient.

While all these are happening – there are very few signs of uptick in growth. In fact, The latest figures for industrial production showed output stagnating in August, rising just 0.4 per cent year-on-year, with manufacturing and capital goods both falling over the year. Any measure to prop up growth will be helpful. One such measure is lowering RBI lending rates. This makes borrowing cheaper thus giving a fillip to purchases and economic activity – such as for housing, consumer goods, electronics, manufacturing .

Thus focus should be on growth rather than taming inflation. Govt. has taken many steps in this regard – but lot needs to be done. There is also an urgent need to build rigorous model for Indian economy – this should be possible due to availability of much better communication/ IT infrastructure and skills in the country at present.



I will be pleased to hear your views

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