May 11, 1998

To fight poverty and promote growth, keep fighting inflation.

Jairam Ramesh

So far, the finance minister has been the epitome of sobriety and sound economic sense. That is why his recent outburst on inflation is at once perplexing and disturbing. Yashwant Sinha seems to think that a tight money policy is being followed. He believes this has choked growth. He adds he is not one who believes in controlling the inflation rate at the cost of growth.

The finance minister is a politician. He need hardly be reminded that in our country, where the organised sector accounts for less than 15 per cent of the workforce, an anti-inflation strategy is the most powerful pro-poor policy any government can adopt. After all, inflation hurts workers and families in the unorganised sector the most.

Sinha will surely not disagree with this. He will not disagree that in a vigorously democratic and increasingly media-driven society like ours, the tolerance levels for Latin American or east European-type inflation rates are very low. Double-digit inflation is a spectre dreaded by all knowledgeable occupants of North and South Block.

Where Sinha will disagree is with the reasons why the current inflation rate is low and just refuses to rise. It is now well below 5 per cent. This has come about not because of cyclical factors arising out of a tight money policy but because of structural reasons. In recent times, the money policy of the RBI has been anything but tight. In 1996-97, money supply grew by 16.2 per cent and in 1997-98 by 17.1 per cent. In 1997-98, the total credit flow from banks to industry doubled over the previous year. The momentum has been kept up in 1998-99 as well.

India is now more open to international trade than it was a decade ago, though not as open as it should be. This has worked to the advantage of the Indian consumer. It has forced producers to keep their prices low, since the domestic buyer now has the option of imports in case the domestic producer persists with keeping his prices high. Before 1991, industrial recessions or slow-downs accelerated inflation rates. This is no longer true, a positive fallout of the trade liberalisation initiated in 1991.

The openness and the relatively comfortable foreign currency asset position of over $26 billion has also provided the Government with an opportunity of resorting to the threat of imports. Sometimes, the credible threat of imports has a disciplining effect on domestic prices. The most recent example of this is the wheat market, where the import window has helped dampen speculation and driven down domestic prices.

World prices in many industries are in check because of over-capacity and recessionary conditions in major exporting countries. International prices of raw materials, intermediates and finished products are at all-time lows. Oil prices have fallen. For the first time, falling diesel prices in international markets have been translated into lower prices at home.

Reduction in inflation rates helps not just the poor. In managing our international competitiveness, what matters is not the nominal exchange rate but the real effective exchange rate. This is the exchange rate in relation to a basket of currencies of our major trading partners, adjusted for differentials in interest rates. Reducing our inflation rate has the same effect on competitiveness as a depreciation of the rupee.

Inflation rates in India are low not just because of an open macro-economy but also because price adjustments haven't been carried out. The issue price for foodgrains is about 40 per cent of the economic cost for consumers below the poverty line and about 70 per cent for those above, as identified by state governments. If issue prices are raised, the inflation rate may increase by at least a percentage point.

Inflation rate averaged 9 per cent in the '70s and 8 per cent in the '80s. In the first five years of this decade, it was around 10 per cent. There was also pressure on the rupee. A tight money policy was needed to prevent the flow of funds from the domestic money market to the forex market. This was the background to the anti-inflation measures adopted by Manmohan Singh in 1995-96, to which Sinha seems to have reacted.

Rather than fall victim to the explanation blaming the 1995-96 policy for the contemporary industrial slowdown, Sinha will do well to read the Sukhamoy Chakravarty Committee report on monetary policy. It had targeted 4 per cent as the acceptable rise in prices that could meet the objectives of growth and social justice.

Sinha would also do well to recognise it is not the RBI's tight money policy that is hurting industry and trade. It is the unwillingness of public-sector banks to lend that is. This will persist as long as the Government continues to be the majority owner. Sinha must focus on reforming the credit-delivery system and not undermine the battle against price stability and inflation. It takes years to dampen inflationary expectations. But no time at all to rekindle them.

Industry and Murli Manohar Joshi want a loose fiscal policy. Sinha does not seem to be averse to a loose monetary policy. This is a dangerous brew. The cocktail of a lax fiscal and a lax monetary policy will spell doom for us. Be an inflation hawk like your predecessors, Mr Sinha.

The author is secretary of the Congress' Economic Cell.

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