Fighting inflation successfully requires understanding the nature of the beast. On this matter, there seems to be an extraordinary confluence of thinking between the central bank and the government, which is good and portends concerted action.
This is evident from the Finance Minister's suo motu statement on inflation in Parliament, and the RBI Governor's address on the challenge of food inflation at the annual conference of Indian Society of Agricultural Marketing, both, by coincidence, released on November 22.
The sum and substance of these two observations is that the Reserve Bank of India has done its part on the demand side, and the government has to do a lot more on the supply side. Governor D. Subbarao chose to address, in a candid manner, the issues relating to supply-side management, only to drive home the point that the ball was now in the government's court.
The government, according to the Finance Minister, has initiated a multi-pronged response on the supply side, but for obvious reasons will take some time to produce results.
The RBI's goal of containing the core non-food manufacturing inflation has been by and large successful, but food inflation is fuelling inflationary pressures a second time round.
INFLATIONARY BUILD-UP
Food inflation increased from 7.3 per cent in 2008-09, to as high as 18.5 per cent in 2009-10, but came down significantly to 6.8 per cent in 2010-11.The build-up during the current year, up to October, had, however, been 9.5 per cent, against only 6.4 per cent in the previous year. During that period, non-food inflation increased from a negative 0.1 per cent in 2008-09, to 7.5 per cent in 2009-10, and further to 10.8 per cent in 2010-11, but thanks to the persistent anti-inflationary stance of RBI, the build-up, up to October in the current year was only 3.2 per cent, against 4.2 per cent in the previous year (Table 1).
If the transparently-indicated target of the RBI, namely the core non-food manufactured products' inflation is taken into account, the build-up during the current year has been only 2.2 per cent, against 3.0 per cent last year. The expectation of both the government and the RBI is that the inflation should come down by March 2012, to around 7 per cent. This depends very much on supply side responses. The Governor is, therefore, right in pointing his finger at the government in facing the current challenge of food inflation. If the supply side response isn't up to the mark or gets delayed, then the burden of containing inflation in the current environment will disproportionately fall on monetary policy, with a significant impact on growth. That should be the least-preferred choice.
WAGE-PRICE SPIRAL
Addressing the challenge of food inflation has become complex for a variety of reasons. The responses, such as raising productivity, increasing capital formation, reversing land use, farm and non-farm occupational pattern, and improved water management etc., which will produce results in the medium to long term, nevertheless require attention. The Twelfth Five-Year Plan should address this issue in coordination with state governments, which have the Constitutional jurisdiction regarding agriculture and irrigation.
What require attention are interventions relating to public distribution system, pricing and taxation policies, besides supply chain management.
The Government may find it very difficult to resist the temptation of raising the minimum support prices (MSP) of essential items. The extent of increase in MSP had been several times more in the last four years, beginning 2007-08, than the increase during the preceding four years since 2003-04 (Table 2). The system also indirectly led to the ballooning of subsidies. Since the MSP is based on cost-plus pricing, which would include an element of wage indexation, it has resulted in an extraordinary rise in real farm wages and created a vicious cycle, which the government must break.
Secondly, the amendment to the Agriculture Produce Marketing (APM) Act needs to be carried out quickly, so that the cartel in supply chain is broken and the difference between farm gate and retail prices is narrowed for the benefit of both farmers and ultimate consumers.
Thirdly, apart from APM legislative reform, the inter-ministerial group recently made a strong recommendation in favour of multi-product retail reform, including opening up of foreign direct investment into this area, albeit in a regulated fashion. Fourthly, as is being debated, there is scope for reducing State-level taxes on agricultural products.
Last, but not the least, while the increased pressure on food inflation due to the employment guarantee scheme is highlighted, the need to curtail conspicuous consumption, particularly during marriage and festival seasons, hasn't received any attention. One tendency in food inflation, in recent years, has been that it hadn't eased during the second part of the fiscal.
The second Prime Minister, Dr. Lal Bahadur Shastri, introduced a scheme of ‘miss-a-meal' every week, during the time of the first Indo-Pak war in 1965. The Government should consider introducing a similar measure, apart from of introducing an appropriate expenditure tax that could moderate seasonal spurts in conspicuous consumption.
(The author is Director, EPW Research Foundation. Views are personal.)