|Income versus inflation|
|Wednesday, 25 July 2012 00:00|
At current inflation levels, GDP growth of 6% is needed to protect real incomes of the poorest 20% Indians
Most analysts, including in RBI, will tell you inflation is India’s biggest problem right now; indeed, RBI Governor Duvvuri Subbarao was on record recently as saying inflation was at a level where it was hurting economic growth. If inflation is allowed to go unchecked, the argument goes, inflationary expectations get embedded into every economic player’s actions, and runaway inflation is the result. No economy, the experts will tell you, has grown in the long run without having inflation under control.
In the current context of whether RBI should cut interest rates, the question is whether monetary policy can help if the government doesn’t do its bit as well, whether in terms of reducing consumption (fiscal deficit) or removing supply-side constraints (whether in the industrial or in the agricultural sector).
According to the latest inflation data for June, as well as for a long time before that, the real problem appears to be food inflation. While food inflation continues to rise, to 10.81% in June (April-May food inflation is even higher than it was last year), core inflation has been falling steadily and was 4.9% in June as compared to around 8% levels a year ago. In the January to June period, food inflation rose to 9.5% while for fruits and vegetables, it was a mindboggling 32.5%—overall WPI in this period, however, rose a much lower 3.5%. If you take a much longer period, from FY05 as BNP Paribas economists Richard Iley, Dominic Bryant and Mole Hau do, you find the results are pretty similar. Since FY05, prices of protein sources in the WPI have risen by a whopping 113% while everything else in the WPI basket rose just 59%.
In other words, the inflation problem we’re seeing largely seems one driven by supply constraints in agriculture more than anything else. Which is why the required policy actions are also pretty well known. Since agricultural productivity is strongly correlated to government expenditure on infrastructure like irrigation, very clearly the Centre has to move to cut subsidy expenditure that, right now, is around 4 times that on agriculture investment. Given the sharp difference between wholesale and retail prices—the difference in food-WPI and food-CPI is more than 100% and is rising dramatically—the action lies mainly with the state governments, and they need to free up agricultural markets. In the case of foodgrains, for instance, around 14% of the food subsidy comprises mandi taxes levied by state governments like Haryana and Punjab. Equally, it is obvious there is little RBI can do by way of policy action to curb such inflation, short of squeezing off all growth completely.
But while the Central government will take ages to move—just clearing an extremely simple demerger of land from VSNL, where there was no opposition of any sort, took a decade!—and the states are not even planning to, India has a more serious problem. If RBI refuses to cut interest rates until the government gets its act together, even though core inflation rates are trending down to comfortable levels, India looks all set to get into a stagflation situation.
Independent consumer economy expert Rajesh Shukla, whose work on the Great Indian Middle Class is well-known, has an interesting analysis in this context. Shukla takes the monthly expenditure of different quintiles from the NSS for both 2004-05 and 2009-10 and examines the changes in real expenditure for each quintile for different expenditure groups. So he finds, for instance, that while the lowest 20% of households (the bottom quintile) saw their real expenditure on food items rise 13% in this period, it rose 11% for the topmost quintile; education expenditure rose 34% for Q1 but 68% for Q5; and so on.
The most important thing, from the point of view of the growth-inflation tradeoff, however, was the rise in real expenditure levels for different quintiles. For the lowest quintile, in real terms, the hike in expenditure was R260 per month from 2004-05 to 2009-10. In other words, that means you need an additional annual income of R600 to neutralise the higher cost—all calculations are in real (2004-05) terms.
If you now move to the hike in household earnings that accrue for every hike in GDP growth—the higher the GDP growth, obviously, the higher the earnings—only a 6% GDP growth can generate a hike in annual income to compensate Q1 households for their additional expenditure. Indeed, given the higher inflation over the last few years, a 6.5% GDP growth is probably the minimum required for a status quo.
But, some will argue, if inflation levels are lower, you can do with even a 5% growth. Possibly, but given that uncontrollable food inflation is the biggest driver, in the short run, there is no alternative to higher GDP growth.
|Last Updated ( Saturday, 28 July 2012 06:40 )|