The
coming weeks are to witness two important economic policy
announcements. The first is the next review of monetary
policy due at the end of January. The second is the
budget slated for the end of February. These policy
interventions would have to contend with what appears
to be a mixed picture of the state of the economy. The
good news is that the Central Statistical Organisation
has put out a reassuring estimate of growth in the economy,
with a better-than-expected recovery in the second quarter
(July-September) of 2009-10. GDP growth that quarter
was placed at 7.9 per cent relative to the corresponding
quarter of the previous year. This was not only way
beyond growth rates in the previous three quarters when
they averaged between 5.8 and 6.1 per cent, but even
marginally above the growth rates in the first two quarters
of 2008-09 when the effects of the global recession
were just beginning to be felt. This sharp recovery
has triggered official speculation that growth in 2009-10
would be 7.5 per cent or more, and that India may even
see a quick return to the 9 per cent growth trajectory
of the five years preceding the slowdown in growth.
The bad news of course is that the overall rate of inflation
and especially the inflation in food prices still continue
to climb. Even though inflation as measured by the Wholesale
Price Index is below double-digit levels (even if climbing),
the consumer price index is rising at close to 15 per
cent on a month-on-month basis and food price inflation
is still close to 20 per cent. These trends on the growth
and inflation fronts obviously signal that the problem
to be immediately addressed is inflation and not low
growth or a recession. Not surprisingly, while one section
of the government argues that it is still too early
to withdraw the fiscal stimulus it claims to have put
in place to stall the downturn, another is increasingly
convinced that it is time now to shift attention to
holding down inflation by reining in public and private
expenditures.
The government's decision to dampen inflation by augmenting
supplies to the market through increased releases of
stocks it holds and larger imports of commodities like
sugar has partly exhausted one of the options it has
at hand. If this effort at supply management does not
dampen the speculation that is clearly responsible for
recent increases in the prices of essential commodities,
other measures will have to be sought. These would involve
reducing access to credit and raising interest rates
in the monetary policy that is to come, and limiting
deficit-financed expenditures in the budget for the
coming year. Till recently, credit growth has been sluggish
in the economy. In fact, as of January 1, 2010, the
growth in bank credit was placed at 14 per cent for
2009-10, as compared with the 17.5 per cent recorded
in the previous year and the target of 18 per cent set
for the current financial year. But more recently there
appear to be signs of acceleration in credit expansion.
According to figures recently released by the Reserve
Bank of India, bank credit rose by Rs. 79,514.51 crore
during the fortnight ending January 1, as compared with
the average credit off-take of Rs. 21,000 crore in the
previous two fortnights. As a result, expectations are
that the Reserve Bank of India may mop up liquidity
by hiking the Cash Reserve Ratio imposed on banks and
raising the indicative repo (interest) rate by anywhere
up to half a percentage point.
Similarly, there is no doubt that the budget for 2009-10
would reflect a large fiscal deficit. So though last
minute disinvestment may generate some receipts for
the budget for 2009-10, the level of the fiscal deficit
and the extent of borrowing in that year are bound to
be high. This would only strengthen the case being made
by those who want contractionary policies to deal with
inflation.
The impact that moves of this kind would have on growth
is likely to be considerable. A substantial part of
the so-called "stimulus" that is expected to generate
the fiscal deficit this year was not engineered but
fortuitous. With the government having had to set up
a Pay Commission for its employees and implement its
rather generous recommendations, which involved paying
a large amount as arrears, a substantial increase in
expenditures was inevitable. What has happened is that,
because of the global recession, something that would
have otherwise been considered a "burden" that threatened
fiscal stability was in the wake of the crisis presented
as a necessary increase in expenditure in response to
the downturn. If we exclude this unavoidable expenditure,
especially the payment of a large amount as arrears
for the period from January 2006, the size of the stimulus
adopted specifically in response to the crisis collapses.
Thus, even if the actual stimulus measures, in the form
of tax cuts or increased expenditures, are not withdrawn,
central government expenditure would be curtailed at
least to the extent that once-for-all arrears payments
would not feature in next year's allocations. Since
the government has been treating all the increases in
its expenditure (during last and this year) as being
a consciously adopted stimulus, a reduction in the estimated
"stimulus" during the next fiscal is unavoidable. If,
in addition, the government chooses to reduce or even
keep constant the actual stimulus launched in response
to the downturn in the form of new expenditures other
than its wage and salary bill, a significant decline
in aggregate expenditure that has a countercyclical
influence is the obvious consequence. The question,
therefore, is whether this would leave the recovery
untouched without affecting inflation.
An interesting feature of the recovery in GDP growth
in the second quarter of 2009-10 is that, when analysed
from the expenditure side, much of it has been on account
of an increase in the government's Final Consumption
Expenditure. This component in the national accounts
is the one which captures the effects of the implementation
of the Sixth Pay Commission's recommendation. Its importance
can be gauged from the following: The sum total of Private
Final Consumption Expenditure, Goss Fixed Capital Formation
and Exports which grew at 10.02 and 8.76 per cent respectively
during the first and second quarters of 2008-09, registered
changes of minus 0.51 per cent and a meagre 2.44 per
cent in the first and second quarters of 2009-10. On
the other hand, Government Final Consumption Expenditure
which registered changes of 0.19 and 2.19 per cent respectively
in the first and second quarters of 2008-09, grew at
a remarkable 10.24 and 26.91 per cent in the first and
second quarters of 2009-10. Thus the recovery was largely
the result of an increase in Government Consumption
Expenditure, which would fall both because of the absence
of the windfall Pay Commission arrears payments in the
next fiscal and because of any reduction in the government's
stimulus.
Thus, the evidence indicates that, everything else remaining
the same, if the government does not increase its outlays
in areas other than wages and salaries in the next fiscal,
we could experience another downturn. India too seems
set for a "double-dip" recession, especially because
the expenditure under the arrears head would not be
undertaken and is unlikely to be substituted with some
other set of outlays. In the circumstances, thinking
of dealing with inflation by tightening monetary policy
and exiting from the fiscal stimulus may not be altogether
a good idea.
What is more, there are reasons to believe that an exit
from the stimulus may not be the best way to deal with
inflation given its features. To start with, the inflation
in food prices has been with us for some time now, including
during the phase when growth had slowed. That is, it
has been underway even when there has been a contraction
in overall demand. Reducing demand, therefore, does
not guarantee a reversal of the food price increase.
Second, while food price inflation has accelerated after
it became clear that rainfall in much of the country
during the southwest monsoon was well below its long-term
average, the inflationary process began before the failed
monsoon. So it is not just the expectation of a decline
in supplies that was responsible for the price increase.
Third, the inflation occurs despite the fact that foodgrain
stocks with the government are comfortable, and well
above the buffer stocking requirement. Finally, inflation
has occurred even though the country's foreign exchange
reserves are comfortable, giving the government the
option of importing food to augment domestic supplies
and rein in prices.
Given all this, the unavoidable conclusion is that food
price inflation is not all the result of inadequate
supplies but in substantial measure the result of speculation.
What is called for then is not measures that work on
inflation by reining in growth, but direct measures
to deal with speculators and dishoard their stocks,
while augmenting availability through a strengthened
public distribution system. This is likely to be more
effective and less damaging for the economy. But that
does not seem to be the direction the government is
taking.
|
