Price explosion, pay hike and growth

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The Indian economy has been going through an extremely difficult phase – it has to manage surging inflation on the one hand and accelerate the growth on the other. From the economic point of view, both ‘price explosion’ and ‘slow growth’ are undesirable and unwarranted. Inflation erodes the purchasing power of money, hurts the common people, leads to confusion and uncertainty in the capital market, reallocates the resources to the undesired directions and also disrupts the social, political and moral fabric of the society. It also hurts savers and eventually, it hurts investment and finally economic growth. Likewise, slowdown in growth in a country like India is a major threat to the hundreds of millions of people whose productive capacity is constrained on account of deprived opportunities because of low income. Realising the importance of growth, the approach paper to the 11th Plan states that the plan “will aim at putting the economy on a sustainable growth trajectory with a growth rate of approximately 10 per cent by the end of its period.” There should not be trade-off between inflation and growth. We need growth, and growth needs to be balanced, orderly and inclusive.

Interestingly, the evidence of growth-inflation trade-off in the Indian context is pronounced only in recent times. Till nineties inflation was induced by either monsoon failure or oil price shock. The early nineties was marked by high inflation associated with acceleration in growth. The late nineties witnessed deceleration in, growth as well as lower inflation. Today with the growth rate of 8 to 9 per cent, we have rising inflation which has surged 12.63 per cent for the week ended August, 9 from 12.44 per cent a week ago. The economy grew at an average of 8.8 per cent during the past five years, touching 9 per cent last year. During this year, the Indian economy has been growing at a rate well below that was indicated by recent trends. The Prime Minister’s Economic Advisory Council (PMEAC) in its Economic Outlook for 2008-09 has pointed a gloomy picture of the economy. The PMEAC has projected the inflation to touch 13 per cent in the near term and anticipated that the GDP (Gross Domestic Product) growth rate will come down to 7.7 per cent this fiscal year from a high of 9.1 per cent attained in 2007-08. Releasing the PMEAC report, the outgoing chairman C Rangarajan said “There is a slowdown in agriculture, industry and services and the global environment is not conducive to growth”. If the economy behaves as anticipated by the PMEAC, it will have serious implications on the Indian economy.

A careful analysis shows that higher inflation rate today is largely driven by surging global commodity prices and fuel prices both of which are facing supply side pressures. An additional factor aggravating the high rate of inflation is the increased off-budget liabilities of the government. There are risks arising from higher liabilities both budgeted and off-budget liabilities notably, the farm loan waiver, food and fertilizer subsidies and the implementation of the Sixth Pay Commission Report. According to an estimate, these could amount to 5 per cent of the GDP, over and above the budgeted fiscal deficit of 2.5 per cent. The recent pay hike of the five million central government employees will increase their purchasing power and thereby aggravate the spiralling inflation, which the government has been unable to contain. The effect of increase in government spending due to increase in off-budget liabilities is to make the interest rate high, which does not have any systematic effect on nominal income or real output over a short period of time. Further, if increased spending is financed by printing new money, it will accelerate the growth of inflation, rather than economic growth. We believe this is the economic situation which India is facing today. A high rate of inflation coupled with high rate of interest is associated with a slow down in income and output.

Global factors like food, fuel and fertilizer price hike and the financial sector crisis are in fact responsible to a great extent for both the economic slow-down and raging inflation. However, it is also difficult to accept that global factors are entirely responsible for our inflationary woes. Timely imports, early actions to curb excess liquidity, improving short term supply responses would have improved demand-supply management. Besides inflation, high fiscal deficit including large contingent liabilities, a high current account deficits with faltering growth momentum, and decelerating the growth of agricultural output are some of the areas where the government need to pay serious attention.

Under such circumstances, what should be the policy option of the government to control inflation? Should growth be sacrificed to contain inflation? Should the government emphasis supply side measures and productivity improvement to check inflation?

As a part of monetary policy measures, the RBI had raised the cash reserve ratio (CRR) up to 9 per cent in a short span of last three months. Similarly, the benchmark prime lending rate (BPLR) of the public sector banks and the private sector financial institutions had also been increased making credit more costly for the industry and trade. The recent experience shows that the tight monetary policy pursued by the RBI, since April this year, has not delivered much in lowering the rate of inflation.

India’s primary need is economic growth which needs to be accelerated while maintaining economic stability at any cost. The policy objectives of the government should be growth oriented. But when we are talking about growth, — we need to identify two aspects of growth—its sources and its composition. By ‘source’ we mean the relative contributions of inputs and productivity growth and by ‘composition’ we mean the output mix, i.e. growth contributed by various sectors. Coming to the source, if more focus is given on productivity growth, it will be the antidote to inflation. The unique implication of a given productivity increase is that it enables an increase in wages and profits without requiring an increase in prices. Indeed a productivity increase can even enable lowering of prices. Regarding composition of growth, it is noted that the contribution of service sector and the manufacturing sector to GDP growth, is increasing, while the growth rate of agriculture is decelerating. However, the growth arising from service or manufacturing sector, although employment oriented, it is inflation generating which may be termed as ‘overheating’ in fashionable language. Had the service or manufacturing growth been accompanied by higher agricultural growth we would have had not only higher growth but probably less inflation that we find now.

Low interest rate provides the primary impetus for growth. Hence monetary and fiscal policies need to be coordinated to keep interest rate low. High interest rates or an appreciating currency are deflationary measures and we need to accept this reality.

Inflation is not a consequence of high growth, but of inappropriate and wrong policies. If policies and practices are right, and global environment is conducive, there can be both high growth and low inflation.

(The writer teaches Economics in Gauhati University) source: assam tribune editorial 04.09.08