There?s no balance of possibility crisis

Many India-watchers have dilated their views on our recent growth experience. There?s a view, for instance, of a 21st century phenomenon coloured by the 19th century image of the Indian rope trick. First impressions do have longevity! A leading newsmagazine, once edited by the legendary Walter Bagehot, ran on its cover an eloquent illustration of a tiger, tail on fire and an expression of a pussy cat caught out impersonating a real tiger?somewhat more inspired than the text inside. A leading British financial daily in a recent editorial baldly stated that India’s recent growth had been financed by foreign stock market investors. Presumably, if they decided to leave town, the boy perched atop the rope would come crashing to earth. Another newsmagazine has found in India’s exceptionalism the answer to an old riddle, though it is equally obtuse as to what the riddle or exceptionalism is?that we are a democracy, or whether services dominate our GDP. One magazine let political correctness slip in describing India?s booming print media as “rags”. This is sure getting ugly!

But we share responsibility for this. We have let habits shaped over centuries get the better of our common sense and fuel an over-eagerness for little pats of approval. We have permitted our own discourse to be shaped by the view of others?especially unsound views. There is also the power of the half-truth and meaningless elegance of the analogy. Words have power, even when divorced from content. So, there is a loud buzz in the bazaar, loud enough to drown out the workings of the brain, about this thing that has come to town?a thing by the name of Over Heating. It is, of course, an old and familiar presence; only now, it is dressed up in imported designer clothes, courtesy trade reform. Its old identity forgotten by the younger post-reform generation media, but not so by the older political class; it is mahengai, i.e. inflation?a friend of those out of office and a pain-in-the-neck of those inside.

Inflation, like disease and pestilence, is no stranger to India. Recall when growth was 3% or even 0%? It is no stranger to other developing economies; at hundreds of percent, it was known as hyper-inflation, to be found today only where Robert Mugabe rules. It is no stranger to the developed economy, where through the 1980s it was known as stagflation?high inflation and no growth.

These days it is known by its true name?inflation?and monetary policy revolves around containing it. Like most problems, it is better to understand it in terms of the mundane detail, rather than be seduced by the lure of imagery. When an economy is on a steady course?like the advanced economies today or India of the 3.3% past?if demand is ramped up excessively by fiscal and/or monetary policy, inflation results, from excess demand (over available supply). What does ‘excessive’ mean? When demand creation runs way ahead of supply creation (investment in new capacity). In today?s globalised world, there is additional leeway in the form of global supply. However, if the entire world is growing nicely?as it is today?we can, and do get global shortages and the attendant prices. So, at signs of inflation rising above comfort levels, monetary authorities raise policy interest rates; money becomes dearer, demand creation is dampened and things return to the steady pace.

India, however, is in transition from a lower to a higher trajectory of economic growth. From the 3% of the first three decades of 1950-80, to 5% of the 1980s, to 6% of the 1990s to something higher in this decade?which seems to be 8% or above. Note the structural changes in our domestic savings and investment rates?from below 25% only a decade earlier to close to 35% today. Nearly half of the growth in recent years has come from investment. Fixed capital formation at constant prices is rising by 18% each year, as against 6% for consumption. Even as our imports have soared, so have our exports, and the trade deficit in real terms has not turned particularly adverse. In fact, the main reason for the increase in the merchandise trade deficit is the rise in petroleum and gold prices. But does not the actual increase in petroleum (or gold) matter? Of course it does, and it does so in a financial sense. We have to pay for it, and in that the remittances made by overseas Indians come in handy. But is the overseas Indian part of the Indian economy? Yes, to the extent of those remittances. The overseas Indian is our very own financial resource, a living and thinking one, and dependable, too?and that is a true bonus. These remittances are not ?another kind of capital inflow?, as stated by those oblivious of the difference between income and liability.

A cut in import duties will bring most domestic prices in line with the prevailing lower international prices. Soaking up excess liquidity will draw the fuel out, and over the first quarter of 2007-08, inflation will fall. Nevertheless, growth can and will continue in what will have to be a tighter monetary environment. The texture of the growth will be dominated more by the new manufacturing and infrastructural capacity?and that is the imperative of sustaining growth.

–Saumitra Chaudhuri is economic advisor, Icra