The challenge of continuing the happy story of high growth and low inflation is proving to be difficult. A year ago, high growth was seen to be stoking inflation, but now slow growth and inflation seem to have different origins. The slowdown in the US economy is putting the brakes on growth and the continued, if slower, growth in China and India is keeping up demand pressures on available supplies and, therefore, prices. If this hypothesis is right, as growth slows, price pressures should also ease. A disconcerting thought, of course, is whether this scenario is now setting limits on the rate of economic growth. The cyclical changes coming from market infirmities seem inevitable. These, however, imply costs on the downturn and gains on the upturn for economies that are just making up for lost time in the past.
The current phase of the global growth slowdown was not unanticipated. There were several indicators of impending problems. For one, the global imbalances in trade and financial flows were a subject of serious concern many months ago. The concern centred around the need for an ?orderly adjustment? of these imbalances and not whether there would be adjustments at all. What is, however, surprising is the continuation of the inflationary trend. High oil and foodgrain prices mean that underlying demand conditions continue to be strong. The decoupling theory has been a straw to hold on to the hope that economies like China and India would continue to keep up their momentum of growth despite slower growth in developed economies. Is high inflation in commodities an indication that these developing economies have resisted the slowdown? This would then imply that high rates of growth for both India and China will prove fairly difficult to sustain at the same time. The implications of two massive economies growing at a pace that will double output almost in a decade cannot but put pressure on resources and supplies. And in a significant way, this is just the beginning as far as India is concerned. So far, it has been urban India driving demand. Rural India is yet to start raising demand. There will be a need to look for a strategy that enables us to sustain high growth without the associated price pressures on commodities that form the basic requirements of people not merely here but across the world.
Inflation in its current phase is driven by basic commodities like food and oil. Short-term alleviation measures would clearly be directed at ensuring that their markets are transparent. This is where much of the psychological stress appears, given fears of hoarding and artificial scarcities. Once these conditions are addressed, fiscal levers appear best suited to deal with inflationary pressures. A fiscal approach would clearly imply reduction in duties and taxes so that the impact on consumers of basic necessities is less. However, these measures would be of a temporary nature, unless the overall supply situation improves. If the supply situation does not improve, then limits to growth would set in rapidly. It would mean the dampening of growth rates as well as the continuation of inflationary pressures.
The issue, therefore, is one of ensuring supplies of the basic items of mass consumption to secure our prospects of sustained economic growth. While global supplies would also increase in response to higher demand, raising domestic supplies appears equally important.
The fiscal choices are, therefore, not limited to merely the short-term balm of tax cuts, but also measures to improve supplies. Accelerating the growth rate of agriculture to nearly double the current levels over the next five years is a goal designed not so much to raise the overall growth of the economy (though this would obviously happen), as to increase the productive capacity of land, so that the increased demand for some basic necessities can be met.
Would this happen without any government intervention? In the absence of easy access to new technologies, the need to increase supplies without having to raise the basic incentive of prices makes government intervention inevitable. In any case, government intervention has been common around the world for meeting the needs of food and oil.
What is not clear is the relative efficiency of these measures. The debate on subsidies versus investment spending has a cyclical phase as well. While investment spending is often a subsidy too, subsidies on current inputs tend to rise over the years, while subsidies on investment respond to fiscal pressures. All this will make production entirely dependent on government interventions. What appears to be required is a set of measures that can enhance the capacity of the agricultural sector as a whole, rather than specific programmes. The objective being to let the sector respond to incentives in an optimal manner. This will also allow the use of resources to become all the more efficient if global markets provide alternative sources of supply or demand.
Shashanka Bhide is senior research counsellor, NCAER. These are his personal views