Inflation is social tug of war

Ajit Ranade
Chief Economist, Aditya Birla Group


How do we settle the growth versus inflation debate? Do we use data, dogma, or both?

Data shows that inflation is a much more severe problem, whereas growth is slowing down palpably but not alarmingly. Inflation is stuck in the unprecedented double digits for far too long. Growth has been declining for six consecutive quarters, but mildly so far. So inflation fight obviously gets priority. There is one hitch. This data comparison is hampered by an asymmetry. Inflation data is about the past, whereas growth concerns are coming from leading indicators (such as PMI or credit).

Are we headed into a severe downturn, and massive unemployment in the future, thanks to monetary tightening? Will the lack of investment spending now lead to acute capacity bottlenecks in the future, further aggravating inflation, and firmly entrenching us into stagflation? Posed thus, the debate begins to sound ideological.

The data is actually less gloomy. Consumption spending which makes up 70% of GDP has been growing at around 8% for the past five years! It may dip by a percentage point this year, but not more. Indirect tax collections are on target. Exports are doing exceptionally well, even correcting for inflated dollars. Non-food credit offtake is still growing at above 20%.

It is investment spending, being cyclical, that needs urgent attention. Private investment component of GDP grew at 20% per annum during 2003 to 2008, and now seems to have almost dried up. These animal spirits lie choked up, not by interest rate hikes, but more due to factors like uncertainty and policy paralysis. Investment spending momentum is infectious, and often undeterred by high interest rates, as during 1995-1997. Reforms, policy clarity and speed of decisions will all help.

Turning away from data to dogma, here are some propositions. Why can't we live with a somewhat higher inflation? It incentivizes producers, and anyway this is the new normal. This is dangerous, since once higher inflationary expectations set in, they lead to wage price spirals, and have no residual incentive effect.

Another suggestion (dogmatic?) says look at Turkey and Brazil, fellow BRIC travellers, who are actually cutting interest rates. That's because they are fighting a different war, that of capital inflows. In any case Brazil has interest rates of 12%, and a reserve ratio of 16%, far above India's current monetary stance.

RBI's repeated reference to its fiscal millstone is best illustrated by two big examples. The National Rural Employment scheme generates less than 2% of employment, but has led to rural wage increases of 30 to 100 %. More than 50% workers hold job cards, and the scheme is flourishing even in highly urbanized states. From an unemployment insurance proxy NREGS has become an entitlement. The second example is of the proposed Food Security bill, which will imply a huge procurement burden, causing food prices to go up not just in India but also globally.

The late former RBI Governor IG Patel, quoting EM Bernstein, said that ultimately inflation is as much a political phenomenon as a social tug of war between one section of society which wants a higher share of income, than the other is willing to surrender without a fight. The RBI's rate hikes reduce the tension of this social tug of war.


(Views are personal)