It is quite clear that the UPA-2 has lost the battle of inflation. Since around August 2009, policymakers have repeatedly forecast that inflation will come down soon. This has happened with a sad frequency over the last year and more. Now, once again, we are told that by March, inflation will be down to somewhere between 5.5%and 6.5%. India used to have an enviable record in being a low-inflation country where policymakers were hyper-sensitive to inflation pressures. They knew that the citizens were sensitive to price rises. Clearly, India has lost that reputation now. The very fact that we are promised a rate above 5% as a success story itself tells you that inflation has low priority in the government?s policy agenda.
In the meantime, food price inflation has resisted all efforts at bringing it down below the two-digit level. Last year, there was some defence in view of the drought of 2009, but this year there is not even that excuse. Another reason was cited that it was the growth in rural incomes, thanks to MGNREGA and other spending spurts, which had increased the rural demand for food beyond its previous levels. In as much as this was unanticipated, it would imply that the income elasticity of demand for food itself had gone up as incomes rose. Then there were suggestions that somehow the urban consumer was robust against food price inflation since the sales of consumer durables, etc, were still buoyant. This seemed to imply that the price elasticity of demand for food in urban areas had been reduced, thanks to higher incomes.
It is impossible to credit these suggestions with any basis unless we see some detailed evidence. What is more plausible is that India has failed to control inflation more as a result of failure of policy than of benign effects of income growth. High income growth need not cause high inflation since income growth implies that supplies have grown just as much as expenditure has. The mismatch has to be explained somehow. It would seem then that as far as foodgrains are concerned, it has to be a failure of the supply side, which caused inflation.
The supply-side failures are of two sorts. Firstly in light of the drought, which was well flagged up before it occurred, there should have been timely release of food stocks to dampen down any price increase. There was a signal failure to do so through the last quarter of 2009 and early 2010. The same happened again late last year when unseasonal rainfall caused a fall in onion output in Maharashtra. Here again the forward markets could see the outcome and traders did what they are in business to do. They anticipated the price rise and bought up stocks. The government, on the other hand, failed to take countervailing action. Hence the spike, how come?
There is no reason other than the fact that the agriculture minister has shown no enthusiasm for his job. He is also unsackable. This lackadaisical response has been constant through 2009 and 2010. Add to this the longer-run failure to improve the warehousing of foodgrains, which has been exposed by the Supreme Court and we can conclude that the supply-side failures are pivotal in the foodgrain inflation.
One may add to these two defects the weakness of the retailing chain from farmgate to the consumer. The numerous small retailers and the myriad middlemen make for a high cost and inefficient supply chain. This also leads to cries of hoarding and profiteering whenever a small supply shock leads to a spike in price as has happened with onions. The defenders of the small traders are also the first to denounce hoarders. They do not admit that the root cause is the very thing they champion. If the government were to shed its timidity in increasing FDI in retailing, it would begin to narrow the spread between the farmgate price and the retail price as well as reduce its volatility.
The supply-side story extends to other sectors such as infrastructure where again the pace of road building has slowed down in the last two years. Power shortages remain a problem again due to the shortfall between targets and achievements in the sector. Public sector companies are failing to meet their targets laid down in the Plan.
Despite these shortfalls, the output growth story continues to be good. So credit where credit is due. Fiscal and monetary policies have been sound. There has been no undue tightening of monetary policy. India has not panicked in wake of inflows of capital and has let the economy absorb the extra capital.
The best anti-inflation policy would be a Cabinet reshuffle, changing the guard at agriculture. But what do you bet that won?t happen?
The author is a prominent economist and Labour peer