Subir Roy: Orthodoxy rules the day

VALUE FOR MONEY

The government's inflation management is being widely condemned and most consider it natural that the central bank should tighten money further since inflation shows no sign of abetting. But it is axiomatic that criticism of policy mostly for the wrong reasons, application of the wrong medicine or even excessive application of the right medicine can make things worse. Instead of having to live with inflation that has come in through the green channel, we may well have to grapple with an economic slowdown, creating a ruinous variation of stagflation and reviving the spectre of the period from 1996 when excessively severe monetary tightening to combat inflation led to a long period of sharply-reduced growth.

Inflation management has till now mainly been through curbing exports of sensitive items, lowering import duties on essentials and raising subsidies across sectors. Of the latter, it is the management of domestic oil prices which has drawn the maximum flak. The government's policy of issuing bonds to oil companies instead of allowing them to raise prices is non-inflationary in the short run but has undermined official fiscal numbers.

However, the last round of rise in domestic oil prices has achieved what always happens under inflationary conditions "" led to sympathetic price rises beyond the actual impact on input costs. Open market prices of cereals and other common grocery items have in the last month gone up by far more than the sourcing cost of retailers. When prices go up and are expected to continue doing so, business at every level jacks up prices by as much as it perceives the market will take. The healthy collection of advance tax, indicating that business is maintaining decent margins despite adverse circumstances, underlines this.

International oil price rises should be passed on to the consumer as soon as possible and in as graduated a manner as feasible so as to avoid shocks. If everybody expects oil prices to reign high for the foreseeable future it is best for the consumer to feel the pinch and curb consumption. Then over time all economic agents will veer round to a less energy intensive regime. While emerging economies are right to protest against all the blame for the global oil price rise being laid at their doorsteps, persistent subsidising of oil prices for their domestic consumers is both shortsighted and counter productive.

The issue of fertiliser subsidy is somewhat different. Early rains and better realisation on their last cereal crop have prompted farmers across the country to go in for early planting of cereals on higher acreage, creating in the process a fertiliser shortage and raising loud protest. The government has also at the start of the kharif season undertaken a major repricing of fertilisers, something it should have done long ago, to make it economically meaningful for farmers to apply a balanced package of soil nutrients. In the process fertiliser prices have effectively been lowered, thus increasing the subsidy burden. With a global food shortage here and expected to stay, it is vitally necessary to sharply raise food output. At his juncture, any measure that promotes the balanced use of fertilisers and in the process improves farmers' margins, should be widely welcomed. This subsidy has to come from somewhere and it is eminently sensible not to allow the pace of economic activity to slow down and thus dampen tax revenue collection.

In sum, it is difficult to criticise the government's inflation management much other than its inability to raise oil prices more promptly. While that is indeed sound policy in the longer term, in the short run it would have raised headline inflation even further than the present 11 per cent plus. As for the future, the crucial issue is whether the central bank should go in for more monetary tightening. There are no capacity bottlenecks or asset bubbles right now and so the tightening undertaken till now has had its impact.

Allowing high commodity import prices to pass through to the consumer will create an inflationary surge which will dampen demand on its own. Continuing to tighten money simultaneously will be grossly overdoing things. It will make life extremely difficult for small businesses and dampen business sentiment, affect investment spending and likely add to unemployment. Inflation hurts the poor the most, except those among them who lose their jobs. The latter head straight for destitution. Lower Indian demand for oil imports will not affect their prices (we are price takers in the short run), thus having no impact on input costs. In the longer term the economy will become less fossil fuel dependent and thereby counter the impact of high oil prices. So India simply has to ride out this inflationary episode without further mechanistic monetary tightening.

The reigning orthodoxy holds that in choosing between inflation management and employment (protecting jobs) the former must take precedence. But thinking out of the box, experimenting with alternative weapons, can yield results. Indian and China emerged unscathed from the Asian financial crisis of 1997 mainly because they had earlier eschewed orthodoxy by retaining a good degree of currency controls. The strength of orthodoxy can be gauged from the RBI governor's recent assertion that "we do not take a view on asset prices." This when 'maestro' Alan Greenspan has fallen from grace for letting the US housing bubble grow and inflicting on the whole world the consequences of the sub-prime crisis.

subir.roy@bsmail.in