Friday, March 02, 2007

Inflation! Why should India care?

There are two people - one a 70 year old man seen the best of his life and in a hospital bed and another is a 18 year old healthy boy playing an aggressive soccer game. Now, a rise/drop of blood pressure for the former by even a few percentage requires immediate attention and intervention by the doctors. But, what about the latter? Should same yardsticks be applied? Should the doctors barge in the middle of the game, and medically intervene if the heart rate marginally increased above 70?

This is the game that is currently going on in India. The pundits at Reserve Bank of India (RBI), worry day-in day-out anxiously watching the inflation jumping around 6%. They have reasons to worry. They follow a lot of practices of the US Federal Reserve, Bank of Japan & European ECB that have set their main mandates as controlling inflation, and growth is a footnote for them. But, at some point those worriers at RBI should ask themselves - are the comparisons valid? Inflation control makes sense for Europe, Japan & US that have had their best times, whose people lead a comfortable life currently, whose growth rates are barely a few notches above ZERO, and small changes in this stable economic equilibrium can wreck people's life-long savings and bring financial disasters. In many sense, they are like the 70 year old man - survivability and maintaining status quo is the key.

But, what about India that has just started to grow. Majority of its people are poor, not many have too much of life-long bank savings to worry about losing a percentage due to inflation, and a lot of development is just waiting to happen. Simply, status quo and economic equilibrium is not an option. If it a'int grows, it dies. As simple as that. In this condition, with growth rates clocking in excess of 9% and bank interest rates above 8%, why does a 6% inflation bother anybody? And a lot of this 6% is due to global factors including global rise in prices of wheat, corn & dairy, along with sky-rocketing oil prices, commodities including metals and increase in transportation costs.

Secondly, this higher inflation coming after two years of unusually low inflation rates. Before that period, even double digit inflation was not unusual. Thus, another part of the game is a lower base to start out with.

Third, apart from global forces, a lot of inflation is due supply side forces - less availability of developed urban areas, rusty food production and full capacity utilization in industries. A healthy inflation rate can and will encourage more entrepreneurs to add capacity and build more production. Farmers will be eager to increase food production and property developers can wipe out scarcity in good urban development. An artificial intervention, puts water in all these positive developments and precludes natural development that should have happened.

Fourth, increase in interest rates have put enormous strain on government finances and non-plan expenditures have skyrocketed leaving little for capital & infrastructure expenditures and this will cause further damage to this fragile nation badly in need of development.

So, its too early for RBI to nose in and spoil the exciting game. Simply, its interventions are unwarranted and unnecessary - the 18 year old boy can take a bit more increase in heart rate and can enjoy the game. RBI is dealing with a healthily growing country, not some ageing nation.

Last but not the least, RBI is a tiny factor in the world game with gazillions of liquid money. When US Fed, ECB & BoJ are finding it extremely hard to rein in this flood, its preposturous for RBI to think of putting brakes on it. If you are pressing too hard on a wet soap, you know the consequences. So, RBI should know its limitations, and carefully guide the game externally instead of its fiats to banks.

Rollback the interst rates close to international levels and work with the government on producing proper development and consider sector-wise tightening of capital through well-guided regulations.


Swami said...

That's a good article about inflation. But the people below poverty line in India, are having a tough time. For example, my house's domestic help, says that it's very expensive for her to buy vegetables these days. So the point is "Growth over here is not inclusive". Would you like to comment on that?

Balaji said...

I agree to the previous comment. Inflation hurts poor quite a bit. But, problem is squeezing is not a solution at all for this.

In the previous articles I've stated why oil subsidies in India makes sense. But, things can't carried beyond a certain extent. When oil prices jump by 4 times, Copper & Steel by 3 times and corn by 2-3 times in the last few years, how many governments can withstand inflation?

So, this "Growth should be inclusive" has become such a rhetoric that any & every stupidity of governments are catered towards that.

The issue is that India's poor are not getting the fruits of globalization? Why? Because they are not globalized. I dont know wh this simple truth does not touch people.

Government has to liberalize agriculture, retail and small scale industries to get them to world class, so that India's poor will have chances to participate in globalization. I've talked about this in a number of articles in this blog.

Without addressing those concerns, "Inclusive Growth" will be only "Elusive Growth".

No government can avoid the temporary pains associated with growth for an economy sleeping for 1000 years... but, they could guide by better education for all, and better reforms so that long term pains can be avoided

Vinayak Hebbagil said...

High inflation does not necessarily mean that the country is growing.But steps trying to control inflation may hurt growth.Which is exactly what we dont want at this juncture.Apart from the supply side issues that are a major part of the problem theres another reason-wasteful government expenditure.Its only when elections are around that they start to worry.
And then the RBI has to step in.
Great blog btw !!

Anonymous said...

I agree with you. The RBI is over-reacting to inflation. They are learning from the Fed and BOJ instead of China. In our situation, growth is more important than price stability.