Inflation and Growth in India: Policy Responses of the Government

Double digit inflation returned to India after many years in the middle of this year. The inflation figure for the various commodities is shown in the graph.

From the chart it is seen that the overall inflation rate in India increased from a low level of around 4% in first week of January 2008 to more than 10% by the first week of June 2008. Subsequently, the inflation rate continued to increase crossing the 12% mark in the first week of August. Thereafter, while the inflation rate decreased, it continued to be above 10% till the last week of October. Since, then the overall inflation rate has declined to 8.4% in the week ending 22-11-08. Before going into the policy responses to this high inflation in India, let us first look at the inflation rates of major commodities.

From the above graph it is clear that all major commodities like primary articles, manufactured products, fuel, power, light and lubricants, registered significant increase in the inflation rate. These three sets of commodities more or less comprise the overall price index. Thus, the movement of these three sets of commodities explains the overall inflation rate in the economy. From the graph it is clear that the commodity group fuel, power, light and lubricants witnessed the highest inflation rates touching 19% in the week ending 02-08-08. Subsequently however, there is a large fall in the inflation rate of this group of commodities as is seen in the above graph.

This weight of this group of commodities is 14.23 in the overall index. Thus, such large inflation in this group is bound to affect the overall inflation rate in the economy. Moreover, fuel being a key input in almost all the commodities, any hike in the price of fuel consequently leads to a cascading effect on the prices of all other commodities. Now, the question is what explains the huge rise in the inflation rate in this group of commodities. Firstly, this increase is largely because of the increase in fuel, particularly oil prices in the global market. This increase in the oil prices in the global market was largely on the basis of speculation. There was no discernible decrease in the supply of oil or a sudden increase in demand. Still, the oil prices increased based on speculation. (See ‘Is the Present Crisis Ricardian?’, Prabhat Patnaik, http://pd.cpim.org/2008/0615_pd/06152008_9.htm). Indian economy being a part of this globalized world had no option but to allow for an increase in prices. This however was compounded by the fact that the excise duties and custom duties on crude oil in India are high compared to other countries.

As far as manufactured products are concerned, it is seen from the above graph that this set of commodities also witnessed double digit inflation, which later on decreased. Manufactured products’ weight in the overall index is 63.75. Thus the overall inflation rate is decisively influenced by the inflation rate of the manufactured products. The inflation rate in the manufactured products has been largely driven by the increase in raw material prices as well as increased demand for steel and other metals in the international market driven by the construction boom in China and India. The good news however is that the inflation rate for the manufactured products has also declined from its very high level.

The most worrying aspect is the inflation rate of the primary commodities. It is seen from the above graph that like every other commodity groups, the primary commodities too have witnessed double digit inflation. Food is the most important component of this group of commodities. Now, food being the most important item in the consumption basket of the poor, such high food inflation adversely affects the poor to a great extent. It must be conceded at one level that this high inflation in food prices was also an international phenomenon, where many factors contributed to the increase in the food prices. The most important of these reasons being the shifting of land from food production to the production of bio-fuels, drought like conditions in Australia and Ukraine and also speculation. In the case of India however, what is most worrying is the fact that while inflation rates for all other commodities have decreased below the double digit mark, the same for primary commodities remains around 12% showing no declining trend. In other words, it can be said that while the overall inflation rate has declined in the country, the poor are still facing a difficult situation because of the continuing higher food and other primary commodity prices. The question is what explains this overall movement in the inflation rate of all the commodities? This brings us to the issue of the Government’s response to the question of rising inflation in India.

Government’s main response to the question of inflation has been to try and manage it through monetary measures. This is reflected in the fact that the RBI increased all key rates (like Cash Reserve ratio, repo rate etc) in the economy which was followed by the banks raising the interest rates for home loans and other loans. This was done with the basic assumption that with an increase in the interest rate, the demand in the economy will decrease and this will lead to a reduction in the inflation rate. On the face of it, this remedy seems to have worked, given the decrease in the inflation rate as has been discussed above.

However, there are some problems with the overall policy of the Government, which are enumerated below. Firstly, conceptually speaking inflation can hurt the poor only in a situation where all prices other than the wages rise, which is a reflection of excess demand for the commodities. In the case of India, the most obvious example is food price which has continued to increase even when other prices have more or less subsided. This increase in the food prices clearly has not been checked by the policies of the Government. This is because the root cause of the increase in food prices in India lies in the fact that with prolonged years of demand depression particularly in Indian countryside, agricultural supply has been adversely affected as a result of a squeeze on the peasantry. Added to this is the issue of futures trading and other speculative activities introduced in the market for agricultural commodities. The solution to this food price increase cannot be merely some rate cuts announced by the RBI. Rather, what is needed is additional expenditure on the part of the Government in the rural economy of India to resolve the agrarian crisis afflicting the Indian economy. Only then can there be sustained growth in agriculture reducing the food prices. Universalisation of the Public Distribution System and proper enacting of the Rural Employment Guarantee Act should be undertaken in order to ease the burden on the poor.

It is however the case that the prices of other commodities excluding food have decreased significantly as compared to the double digit inflation figures. It cannot be ascertained how much of this decrease in the inflation rate is directly because of the policy announcements of the Government and how much is because of international factors. Since the month of September, an unprecedented financial crisis having the potential of turning into another Great Depression has hit the world economy. As a result of this crisis, there are recessionary trends in all advanced countries including USA and Europe. As a result, the world economy is currently facing very low growth potential. With the slowing down of the industrialized economies, the price of oil has drastically reduced. This is because it is expected that the world economy will slow down even further, which will result in further decrease in the price of oil with its demand slowing down. This expectation is forcing speculators to sell oil for some other commodity, notably gold, which is resulting in a fall in the prices of oil. At the same time, the price of steel has also witnessed a fall because of the lack of demand in the world economy. In short with the possibility of a global recession, the international prices have actually fallen. This would have surely impacted the domestic price level in the economy. So, it is unclear as to how much of the decrease in inflation is a result of the policies of the Government.

Now, with the financial crisis hitting the Indian economy and the possibility of a global slow down, the policy direction is again focused on ensuring that the growth rate does not fall too much. In order to ensure that the Indian economy is not hit by a recession, the Government has come out with a stimulus plan, the salient features of which are the following:

• The Government has proposed to increase the Planned expenditure by Rs 20,000 crores.
• To ensure additional spending to boost demand, the Government has reduced the Cenvat tax by 4%.
• Interest rate on export credit has been reduced. Additional funds of Rs.1100 crore will be provided to ensure full refund of Terminal Excise duty/CST. An additional allocation for export incentive schemes of Rs.350 crore will be made. Government back-up guarantee will be made available to ECGC to the extent of Rs.350 crore to enable it to provide guarantees for exports to difficult markets/products.
• Public Sector banks will announce a package for the housing sector loans while the RBI will put in place a refinance facility worth Rs 4000 crores for National Housing Bank. There are also plans to finance the textile sector.
• The Government has decided to boost infrastructure through Public-Private Partnership. The Government has also decided to raise Rs 10,000 crores from tax free bonds.

(Source: Government Announces Measures for stimulating the Economy, http://pib.nic.in/release/release.asp?relid=45377)

The above mentioned measures are aimed at boosting domestic demand through direct government expenditure, excise duty cuts and infrastructure projects. At the same time, the package also entails to boost the export sector in India. Whether or not this package will solve the recessionary trends in India will be clear with time. However a couple of points need to be made at the outset.

Firstly, the fiscal stimulus of Rs 20,000 crores is too small and it is also not clear as to under what heads will this money be spent. Secondly, there is no announcement on the part of the Government to protect the interests of the workers directly, while they are the ones who are facing the brunt of the crisis with massive lay-offs as a result of the global crisis. Thirdly, the finances of the state governments are completely ignored in the package, a point which has been made by the Finance Minister of Kerala. (Central Package Ignores States, Says Minister, The Hindu, 8 December 2008).

There is however a more fundamental point regarding the entire approach of the Government. We were told during the days of high inflation that it is a result of overheating of the economy. Hence interest rates were increased to reduce demand. This however did not result in a decrease in the food prices, while overall inflation came down aided by international factors. Again, with the global financial crisis, the Government decided to cut the interest rates to boost demand. This also did not have the requisite impact because the crisis was a crisis of confidence with the banks refusing to give loans. So, even with an interest rate cut the problem could not be resolved. This over reliance of the Government on the monetary instruments to resolve every problem of the economy stems from the basic position that the Government should maintain fiscal prudence. However, as has been discussed earlier, what is needed to tackle the problems of the Indian economy is to increase the purchasing power of the poor and by increasing Government expenditure particularly in the rural areas. In order to do so, the Government has to come out of the overall hegemony of international finance capital and neo-liberalism reflected in the FRBM Act and the policy of fiscal prudence. Given the neo-liberal commitment of the Government it is improbable that it will tread on this path. The answer therefore lies in the struggle for an alternative set of policies challenging the hegemony of finance capital.