The Reserve Bank of India (RBI) is likely to raise interest rates on January 25. Given that food inflation is still reigning at 15.5 per cent and general inflation is on the rise, having crossed 8 per cent, such a move seems quite inevitable. The RBI will raise rates even if it recognises that monetary policy has limited traction; this is because of continued fiscal expansion, emerging supply shortages and, above all, to signal its firm intent to rein in inflation before inflationary expectations become entrenched.
Inflation would vitiate the investment climate and impose an unbearable involuntary tax on the poorest segments. With fiscal deficit still well beyond levels stipulated by the FRBM Act and the current account deficit threatening to go above 3.5 per cent of GDP, a worsening of inflationary expectations at this time could well be fatal for macroeconomic stability, a necessary condition for maintaining high growth rates and reducing poverty.
The RBI hardly has a choice, even though market interest rates are already high and threaten to choke investment activity in a period when capacity expansion both in manufacturing and infrastructure is needed.
Is there no way out of this trade-off between growth and inflation? There surely is, as is shown by China's non-inflationary, double-digit growth for more than two decades. It is only in the post-Lehman crisis period, which saw a massive fiscal stimulus by the Chinese and several rounds of quantitative easing by the US, that inflation has risen to around 5 per cent in China, but growth continues to exceed 10 per cent. The Chinese experience holds out three lessons for addressing the growth-inflation trade-off. First, to consistently maintain a fiscal surplus and certainly not run a large revenue account deficit. Second, to sustain high rates of capacity expansion in the industrial and manufacturing sector so that supply keeps pace with rapidly rising demand (export demand in the Chinese case, and consumption demand in ours). Third, ensure that agriculture output growth is high and availability of agro-products is never a constraint even if it implies large-scale imports. China imports huge quantities of corn from the US for keeping up its pork supplies, having learnt a quick lesson from ‘pork inflation' a few ago.
These lessons can be learnt and applied to macro-economic management in our country. But for that it is necessary not to accept higher rates of inflation as a given condition, and for policymakers not to declare that food or other forms of inflation cannot be controlled in a large country like India. Statements like these reflect a defeatist attitude.
TASKS BEFORE GOVT
The RBI would do well to make a lot more noise against fiscal profligacy by the Central and State governments. The RBI Governor, who is apparently spending considerable effort in mastering the intricacies of communication should, in plain language, let the people know on January 25 that continued fiscal expansion and failure to rein in inflation will result in slower growth and lower employment.
Besides, a loose fiscal policy forces him to raise rates to prevent inflation from ripping, and blunts his policy instruments. The shoe will then surely be on the Finance Minister's foot.
The most important measure that the Finance Minister could announce to curb inflation will be to delist perishables (fruits and vegetables) from Schedule I of the APMC Act which will effectively de-license these commodities and take them out of the collusive clutches of licensed wholesale traders.
Currently, they operate with impunity and with official connivance in government-managed mandis across the States. The Finance Minister should at least ensure that UPA-run States, especially Delhi and Maharashtra, announce this de-licensing measure simultaneously and challenge the opposition States to follow suit, or face the people's anti-inflation ire. This is the most immediate and directly effective measure to bring down food prices, and inaction on this account will be difficult to justify.
PRODUCTIVITY CHALLENGES
The other major issue is to raise output and productivity levels in agriculture. This is clearly the realm of the Agriculture Ministers, both at the Centre and the States. Agriculture remains a backward sector, contributing a mere 14.6 per cent of GDP while still sustaining 55 per cent of our population. For the great majority of the rural population, this has implied a life just above bare survival levels and no hope of improving their lot even over generations. This poor performance is not acceptable as it threatens to impose a binding constraint on economic growth.
The government must make space for greater private sector activity in agriculture. It can do so by encouraging modern retailers to further intensify their direct supply linkages with producers and, at the same time, actively promote farmers' cooperatives so that bargaining strength remains symmetrical.
The effective modality for establishing these cooperatives will be to bring in private integrators, a la El Tejar in Argentina or Mother Dairy in our country, who will have the incentives to do so. It is time that we jettison the outdated and dysfunctional subsidy-price control, the public distribution system of agriculture development, and let the sector modernise on the basis of private enterprise. If it can happen in manufacturing, it can surely happen in agriculture too.
It should quickly establish the necessary regulatory authority for overseeing the use of genetically modified seeds. This would ensure consumer safety based on scientific grounds and not propaganda and also allow the farmers to grow lower-risk and higher-productivity crops.