Indian inflation has receded, and at 3.2% is now at its lowest level in several years. This has brought cheer to policymakers and maybe some respite to the common man. However, I cannot forget my years in the Department of Economic Affairs between 1991 and 1995, when several MPs would accost us on how we could declare inflation to be declining when prices were on an upward trend. In all honesty, we economists owe it to the common consumer to come up with some other measure that reflects market reality and is still analytically robust.
At the same time, there is the surprising news of inflation in China rising above 5% despite the PBOC having raised interest rates five times by that magical figure of 27 basis points on each occasion. Finally, the Chinese and their economy appear to inhabit the same economic universe as others?until now, it seemed that they had discovered some miraculous strategy that allowed them to indefinitely maintain a blistering pace of above 10% GDP growth with zero inflation (even deflation). But before we start talking of an overheated Chinese economy, it should be noted that if food prices, and specially the price of pork (up more than 60%), are excluded, inflation in China is down to a rather benign 0.9%. And yet, the Chinese government has taken immediate administrative measures by announcing a freeze in prices of several food and other basic commodities. Just like us, the Chinese also seem to be ultra sensitive to price increases.
But the difference is that they have not done anything to adversely affect their exports. The exchange rate is managed strictly to keep its appreciation very gradual; no bans on exports of any products and no caps on inflows of any type of foreign capital. Is there a lesson here for us in India? I think there are several. First and foremost is to not be captive to the macroeconomic theology that has for the most part evolved in the context of developed and stable economies. All standard macro dictums have come from economies where the policy task is to keep the growth rate within a narrow band that is determined by the rate of productivity growth in countries where the workforce is either stable or declining. As the Chinese have shown, conditions in large, young economies like ours are placed so differently that these so-called laws apply with much less rigour and the principal policy task is to maximise employment and achieve stability.
Second, one should do nothing at all to discourage export growth, specially export of manufactured products that ensure higher employment with rising productivity, the only known means for raising welfare levels of large numbers. An uncontrolled rise in the exchange rate (?the market is always right?); bans on exports of skimmed milk, sugar, wheat or of petroleum products (in future); raising interest rates along with currency appreciation; and blanket caps on capital inflows are all measures that hurt exports. Third, supply-side measures, if they have to be taken, should be taken on the basis of regular and detailed monitors designed on the basis of past experience of factors that result in seasonal spikes. For example, over the last 20 odd years, we have seen a seasonal spike in onion prices around this time when the market is dependent on supplies from Maharashtra. These often get disrupted by either man-made or natural causes. Yet, I have not seen any action plan or development of leading indicators that will trigger policy action to thwart the situation, which has directly affected an electoral outcome on at least one occasion. One would expect the political class to be more demanding.
Fourth, we should, however, let markets and economic agents do the job of achieving the required supply response rather than make this into an administrative response (which often lags). Thus, we will, I am sure, have far better outcomes if we simply remove all controls over domestic and international trading of food and other primary commodities. The government will always have the right to intervene and take countercyclical measures, but surely, the market will act on signals far ahead of any ministerial response to an emerging crisis.
Fifth, targeted administrative action, when required, should however be taken with much greater alacrity. Even the last inflationary episode in India, we now know in retrospect, represented supply-side problems and not a general overheating of the economy. But in the absence of regular monitoring and decisive action, we could not take targeted measures and instead had to adopt policies that may have helped to bring down inflation but also adversely impacted exports and could result in the loss of growth momentum.
The one important lesson for me is that with increasing globalisation of the economy and our imperative to achieve inclusive growth, India deserves a quality of governance that is better than international levels simply because our challenges are more complex.
We cannot continue with the illusion that we can achieve our national objectives despite the government. That happens when your population is in decline, as in present day Italy.
?The author is director and chief executive of Icrier, a Delhi based think tank and member of India?s National Security Advisory Board
