More public investment, not inflation required

Updated: Jan 21 2002, 05:30am hrs
The latest report on Currency and Finance (C&F) from the Reserve Bank spouts the D word: deflation. There could be substance in the C&F report’s warning that “it is crucial to prevent inflation and inflationary expectations from falling to deflationary levels”. But how close is the economy to deflation

A sustained fall in the general price level marks deflation. Inflation, as measured by the official all commodities wholesale price index, has been of the order of 2 per cent in the current fiscal so far against 5 per cent a year ago. This is worked out on a point to point basis. On weekly average basis, inflation works out to 4.5 per cent against 6.7 per cent. The price slow down appears sharp. This is because the change is measured over the price level as inflated by the hike in oil product prices a year ago. Since stiff oil prices are slated to remain stable, the decline in the all commodities price index is likely to be sustained; especially since prices of manufactures stagnate (plus 0.1 per cent so far this fiscal against 3.8 per cent a year ago). Note, however, prices of food articles have risen, by 6.9 per cent so far this fiscal against 0.8 per cent a year ago.

Contributing to the whiff of deflation are hikes in oil product prices (26.7 per cent in 1999-2000 and 15.1 per cent in 2000 -2001) and dearer food articles (up 9.3 per cent in 1998-99 and 7.1 per cent in 1999-2000). These have depressed real incomes of a large segment of the population. Aggregate demand growth—in a milieu of investment stagnation—has taken a setback.

Strictly speaking, there has been no sustained fall in the general price level. So, how relevant is the inflation-deflation-growth formula propounded by the C&F report It estimates the growth maximising inflation rate at 5 per cent. A one percentage point reduction in inflation, it states, leads to a decline in output by two percentage points below potential. The trouble is, how to estimate inflation; and how to push it up to the growth maximising rate

Let the various subsidies and tax exemptions grow Reduce tax rates Such steps—implicit in the demand for inflation—might further business in consumer durables but the consequent growth of investment in this sub-sector is unlikely to make a strong impact on flagging aggregate investment. The fresh skew in income distribution will not hike growth as seemingly propounded by the C&F report.

In any case, policy is hardly geared to preventing inflation. Fiscal policy is lax, unfocussed. Monetary policy is expansionary; credit is cheap. Even so, private investment languishes. What is wrong The ‘corporate-promoter culture’ focuses on speculation and windfall gains and not on painstakingly modernising capacity, cutting costs and upping productivity. The saver’s confidence in private corporates is weak: this is obvious from all available market signals.

This brings the alternative of public investment into focus. It needs to be enhanced in infrastructure—railways, roads, telecom, water supply et al. The 90s saw a cutback in public investment.

The resultant decline in aggregate investment has held down growth. Reversing this with enlarged— and efficient—public investment, funded by larger public borrowing, will not necessarily add to inflation—as might be imagined from C&F’s diagnosis—thanks to ample financial savings, excess foodstocks and surplus forex reserves.