Talking about the Indian economic situation, food inflation is obviously the centerpiece issue now. Not only is the issue in the limelight because of the price levels and their rate of increase. Food also warrants attention because it is a basic consumption item. But, looking beyond the present troubles, one will agree that India is not destined to suffer endemic food shortages and high food prices. Whether in terms of availability of arable land or in terms of a moderate climate through the year, there are some inherent advantages India possesses. There have obviously been notable weaknesses in how these have been capitalized upon.
Very many experts have talked in great detail about this and offered policy solutions. The Prime Minister summed up the situation succinctly in a recent speech when he said the food distribution system was hopelessly outdated. One can extend this to the overall rural infrastructure also and say it is not keeping pace with the demands of a growing economy.
From an even more macroperspective, one should note that the inflation pangs the country issuffering now are part of the formidable challenge of managing thegrowth / inflation trade-off.
All countries – big and small – have faced this trade-off. Even the economies now termed “advanced” and “developed” – broadly under the OECD umbrella - have faced this challenge and turbulent times in years past. High variability in economic activity and price levels was quite common in these countries for most of the period from the end of the Second World War till the early 1980s. It is only from around the mid 1980s that most of these countries have had a relatively high degree of stability in output growth (GDP growth) and inflation.
Therefore, looked at from that historical angle, the challenges India faces in navigating through the growth / inflation trade-off are not surprising at all. It is going to take some time for the country to settle down to a trajectory of high growth and acceptable (manageable) inflation. The comforting factor here, though, is that India’s policy, institutional and governing framework is either ready or is getting ready to enable the country to get to that path smoothly. In the progress towards that path, one should also provide for thesignificant uncertainties which global crisis of the sort we have gonethrough in the past couple of years can create.
In this context, it may be pertinent to define what level of inflation would be acceptable (manageable) for an economy such as India’s. Policy clarity on this front could provide invaluable guidance and operational freedom to all economic agents – be they firms, households, government (policy makers). It will not hamstring policy makers with unreasonable / unrealistic goals. It will also not generate unrealistic expectations in the market place – be it among consumers, households or businesses planning to save, borrow, consume or invest.
We would venture to suggest here that India cannot or need not aspire for rates of inflation which the “developed” Western economies have attained after 30 or 40 years of policy fine tuning and “trial and error”. This should automatically rule out aspiring for something like an annual 4% rate of increase in the general price level. This is the rate of inflation which policy makers (the RBI) have been talking about as India’s ideal rate of inflation as it integrates with the global economy.
While a 4% inflation rate may be ideal, we feel that it should be for the long term only. Too much of growth, economic opportunity, employment and incomes may be sacrificed if India were to pursue such a goal in the short and medium term.
What would be more practicable for a country such as India in the medium term – say over the next 5 years – would be price rises of the order of 7 or 8% per annum or to be broader, a < double digit rate of increase in prices. It may be far better to provide policy clarity like that than to saythat we aim for 4% inflation but actually end up with 10%+ rate ofinflation.
Expectations from the Budget
With an economic and policy framework in place like the one sketched above, we feel that the annual budget should ideally become a side show. It should be taking only incremental measures / steps which contribute to the attainment of the larger objectives.That even major fiscal policy measures need not wait for the budget was amply proved by the Government’s rapid (fiscal policy) and outside-the-budget response to the deteriorating overall economic situation around late 2008 / early 2009.
(It should be pointed out here that a significant chunk of economic policy having a crucial bearing on overall national economic performance is formulated / implemented outside of the budget. The policy on inward foreign investments, the rupee’s exchange rate, external borrowings etc are among policies which do not form part of the budget exercise). In normal times, though, the budget continues to occupy pride of placein setting the immediate agenda for government’s revenue andexpenditure programs.
These, in turn, have significant immediate implications in the financial markets and in parts of the financial system. With this background, we expect budget 2010 to initiate steps aimed at expenditure compression and enhancing revenues.
The objective should be to contain government borrowings – at worst – at FY 2009-10 levels – in order to keep overall financing conditions stable and comfortable. Overall financing conditions apply to both government and the private sector.
It is imperative now to keep the overall financing conditions stable and comfortable since the private sector part of the economy is now showing distinct and strong signs of revival from the weakness of 2009. There could be arguments that the revival signs are only because of high government expenditures and therefore it (government expenditures) should continue. A judgmental call is required here. A policy-of-the mean here could be to maintain expenditures and borrowing at previous year’s levels and not allowing any increase.
As an immediate target, we feel that the benchmark government bond yield (10 years) should not be allowed to exceed, say 8%, in the coming financial year. It is currently ruling around 7.85%. That is, 8% should be the target without any explicit RBI support for the government’s borrowing program.We feel that given the current global backdrop, any serious efforts at fiscal consolidation in India may only ultimately be welcomed by the markets – despite some initial hiccoughs or disappointments.
It may also be relevant to point out here that the (global) investment community has an asymmetrical approach as regards fiscal expansionism by developed and developing economies. Developing economies do not always get favored treatment as “risk aversion” and “capital flight” may take hold suddenly. This has to be kept in mind.
T.B.Kapali, Vice President (Economic Research), Shriram Capital Limited, Shriram Group Companies Chennai