At a recent seminar on September 21, on inflation, Kaushik Basu, Chief Economic Adviser in the Department of Economic Affairs (DEA), apparently agreed with the comment of Govinda Rao, (Director of NIPFP and a member of the Prime Minister's Economic Advisory Council) that “the country's economic managers have not been able to fully grasp the processes underlying the persistence of high inflation.” Such a conclusion by the two senior policy makers is deeply disturbing.
Basu has also published in 2011 two avowedly analytical papers in the Economic and Political Weekly , one entitled Understanding Inflation and Controlling It and the other entitled India's Foodgrain Policy, An Economic Theory Perspective . Although they have some useful but largely well-known insights, both devote too much space to theoretical digressions that do not contribute to a deeper understanding of the analytics of inflation, let alone on policies for addressing it.
Although Basu rightly calls for more attention to be paid to macro-demand management through fiscal and monetary policies for controlling overall inflation, his paper, including the section on interest rates and liquidity, has little or nothing to say on macroeconomic theories. His reference to Brazil, having successfully lowered liquidity by counter-intuitively lowering interest rates, is interesting but its relevance to the Indian context is not evident. His digression on capital controls and discussion on the possible impact on inflation of policies that benefit the poor, such as the National Rural Employment Guarantee Act, do not answer the basic question on the determinants of a sustained month-after-month rise in food prices during 2009-10.
Basu's paper on the economic theory of foodgrain management is extremely disappointing as a contribution to India's foodgrain policy, which is beyond the use of buffer stocks for price stabilisation, and, in particular, to containing food inflation. Basu, given his well-deserved reputation as an excellent economic theorist, should have explained the analytics of the role of India's fiscal policy in addressing inflation.
RBI'S POSITION UNCLEAR
Deepak Mohanty, Executive Director of RBI, in his very recent speeches, addresses the role of monetary policy and the RBI in addressing inflation. Mohanty mentions the RBI's goal of achieving a specific threshold level inflation rate as a means for anchoring of inflationary expectations. Since the RBI does not follow inflation targeting in its monetary policy, nor uses a fixed exchange rate of the rupee with a low inflation country as an anchor, it is unclear how it uses the findings from its own periodic survey of inflationary expectations in an analytical way.
The very recent statement of the RBI that it reserves the right to intervene, if necessary, to address the depreciation of the rupee seems to contradict its policy until now, of letting the market forces determine the Rupee's exchange rate, and intervening only to mitigate the volatility in exchange rate movements.
At a recent Confederation of Indian Industry (CII) event in Kolkata on December 9, Governor Subbarao acknowledged that the criticism that RBI's hikes of repo rates 13 times since March 2010 have had no impact on inflation rates is valid, but added, “Had the RBI not acted, the inflation rate now would have been 12 per cent or 13 per cent and not 9.7 per cent at the moment” ( The Hindu , December 9, 2011). This is a merely self-serving assertion, since he did not offer a shred of analytical evidence in support. One could equally well argue that had the RBI acted by raising rates higher once the evidence that mini hikes were not working, probably inflation at the moment would have been much lower than 9.7 per cent.
TEST FOR GOVT
The thesis of food inflation as the driving force of inflation will soon be put to test. The weekly inflation rate in food articles has been declining recently from 12.21 per cent in the week ended October 22, 2011 to 6.00 per cent in the week ended in November 26, 2011. In part, this is to be expected.
With a good kharif crop following a good monsoon, and the beginning of market arrival of the kharif harvest (primary) rice, price of rice declined. Wheat prices have been declining even longer perhaps, following Russia's lifting of the ban on wheat exports. It is too soon to tell if the recent decline of food inflation is temporary, or will be sustained. If it is, it will be interesting to see if the overall inflation rate will begin to decline at the end of this fiscal year, as the government has been forecasting.
Two recent developments have implications for economic policy in general, and for addressing inflation: The first is the already-mentioned good news regarding the recent decline in food inflation. The second is the bad news regarding the decline in real GDP growth in the second quarter of this fiscal year, to an annual rate of 6.9 per cent. Basu has attributed this in part, perhaps euphemistically, to “delays in decision-making” rather than, appropriately, to policy paralysis. Montek Ahluwalia (Deputy Chairman of the Planning Commission) pointed out to an investment slowdown as the cause, but the data do not bear him out.
But both did not refer to the most disturbing aspect, namely, that the decline started from 9.4 per cent growth in the fourth quarter of 2009-10 and continued in every quarter since then. In fact, even the 9.4 per cent growth itself is more a reflection of the recovery from the effects of the global financial crisis. The slowdown in growth had started in the last quarter of 2007-08 before the financial crisis hit, and had its impact on India. I have argued elsewhere that the structural problems, particularly of infrastructural constraints, had made a return after the crisis, to make the average growth rate exceeding 9 per cent during the three years 2005-2008 seem very unlikely.
In any case, Montek Ahluwalia ended a recent interview with Karan Thapar of CNN-IBN with the frank admission: “I regret to say that I have to admit that”, (in response to Thapar's remark) “If inflation hasn't begun coming down by February, then the government really does not know what it is doing.”
(The author is Professor of Economics, Yale University. )
Excerpts from the R. Venkataraman Endowment Lecture, organised recently by the Madras School of Economics