The move by the Reserve Bank of India (RBI) yet again to raise interest rates comes as no surprise. Inflation pressures have remained strong in India for the two years the UPA-2 has been in power. In the first year, there was the excuse of the drought, though even here the countervailing action?timely release of foodgrain stocks?was neglected. The sum total of policy seemed to be the periodic forecasts by policymakers that within the coming six months inflation would subside.
The Budget of February 2011 failed to take the inflation threat seriously. Indeed, there was some complacency that the GDP growth rate had been notched at 8.6% in 2010-11 and was forecast at 9% for 2011-12 in the Budget. But it was obvious that the 8.6% was flattered by the recovery of agriculture from a low base of the previous drought prone year. Foodgrain output in 2010-11 did not exceed the level of two years previously. Yet the high figure was claimed and the higher figure of 9% was enshrined in the Budget.
The Budget did not mention that the nominal growth of GDP in 2010-11 had been as high as 25%, if not higher. The reduction of the debt-GDP ratio was claimed as a positive result but not linked to inflation. But an economy with 15-16% inflation has to be treated as in need of serious cure. It was clear that if inflation pressures were not to be tackled, there would be a setback for growth. I was bearish on the Budget day and thought 8% would be hard to achieve.
Things have got worse. The domestic inflationary pressures may have switched from supply shortage to excess demand, though supply-side bottlenecks remain. The extra factor is the international price rise of oil and commodities, partly thanks to Chinese growth but also due to quantitative easing that is flooding the markets with excess liquidity. The world economy has become tolerant of a slightly higher inflation rate than before the Great Recession because western monetary authorities do not want to kill the fragile recovery.
India has a very loose fiscal policy not only due to the pump priming during the growth recession of 2008-09 and 2009-10, but even now there is no sign of fiscal tightening. The Budget devotes a third of the total revenue collection to interest payments on debt, ten times what it devotes to health or education. There is no urgency about reducing the debt-GDP ratio either by more rapid divesting of public assets or by reining in expenditure.
Indeed, the spending policy of the UPA is being run by the NAC, which does not like liberal reform or even a high growth rate. Yet it loves to spend the revenues collected thanks to the buoyant growth on its pet projects. These are no doubt worthy?NREGA, health audit, food security, etc?but none of them contribute to raising output. NREGA is a stop-gap scheme and does not raise the skill level or productivity of the workers. It may make them grateful when it comes to voting at election times but their poverty will not be tackled by staying at home and working at most 100 days.
It just may be that the UPA is having an aversion to high growth rates lest it may be seen to be worshipping at the Temple of Mammon. The cry of the hour seems to be that the foundation of a welfare state has to be laid in rural areas, at least for BPL families. This again cannot be a bad idea. But the issue is: will there be sufficient growth to finance it?
One strong argument will be made that improving health and providing food security will by themselves raise not only the levels of well-being but also the levels of productivity of the rural poor. This extra productivity would then finance the extra spending. Yet there needs to be some strong quantitative evidence that such is the case. My scepticism is because of the fact that the rural sector, both in agriculture and other activities, is a low productivity sector. Growth has been mainly due to urban manufacturing and services and not rural activities. Indeed, a strategy for poverty reduction would be to move workers from low productivity agriculture and ancillary rural activities to low-tech manufacturing, which can employ unskilled and semi-skilled manual labour. NREGA does exactly the opposite by confining the workers to the rural areas.
My hunch is that in 2011-12, GDP growth will hit below 8%, perhaps as low as 7%. Inflation will be in double digits. With reforms no longer on the forefront and elections looming in UP, the risk-averse Congress leadership will let growth go. Then we shall regret the end of the Indian miracle.
The author is a prominent economist and Labour peer