After many attempts, some very unreasonable, at taming inflation, is the government now trying to talk down 'growth expectations'? Is this part of a calculated decision to sacrifice growth in the quest to quell politically costly inflation?
Inflation is not a pleasant experience for consumers, especially for those at the bottom of the pyramid, even if their income levels continue to rise when economic growth is high. When they complain about rising prices in normal times, governments can afford to wait for prices to settle down. But when elections are on the horizon, consumers become both the plaintiff and the jury and throw the government out.
Unfortunately in modern India, elections have become a regular feature. Hardly a year passes without elections, either at the national level or state level. Media proliferation has ensured that national parties are forced to worry about 'political setbacks' in even politically inconsequential states and parliamentary bye-elections. Even a minor defeat is hyped up as a decisive change in the political climate, which could affect the government's approval long-term stability. This has forced political parties to become hypersensitive to price levels, the one perpetual factor in all elections.
The UPA government has so far been gloating about the unprecedented economic growth achieved during the first half of its term. The leading lights of the government and the ruling party, who were vociferously denying the benefits of the 'India growth story' having percolated down to the bottom during the last general elections, have been quick in appropriating most of the credit.
Most often, such easy successes come at a price and don't last very long. While they basked in the reflective glory of the economic boom, government leaders paid scant attention to the worsening supply side shortages, which had started pushing up prices. Even when there were clear signals about the rising price levels, the government stood back and allowed the Reserve Bank to manage the situation with monetary policy tools. On its part, the RBI was probably not proactive enough during a crucial period last calendar year and kept interest rates steady when its should have considered modest hikes.
Finally, both the government and the central bank swung into action when the situation started getting out of hand. The political losses of the ruling alliance in the recent state assembly elections like Punjab and Uttarakhand were blamed on inflation.
The forthcoming assembly elections in the politically important Uttar Pradesh have made the government even more skittish, even though the ruling party is at best a fringe player in the state.
Desperate men take desperate decisions, which are often not the most effective and sometimes even counterproductive. While the central bank tightened the screws through higher reserve requirements and interest rates, the government tried to bully commodity producers into lowering prices. Some of the fiscal steps announced by the government to tackle inflation, like the differential excise duty structure for cement, worsened the situation.
The only way to manage inflation in a sustained manner in the long run is to ensure that structural bottlenecks on the supply side are removed. Once that is achieved, inflation becomes mostly a 'monetary phenomenon', which can be managed by the central bank to a great extent. But correcting supply side deficiencies, especially in agricultural commodities, needs a lot of political will and foresight. Such structural changes also take time, which is a luxury that politicians, who have their eyes on the next elections, no longer have.
Feeling the heat
So, what can they do when their attempts at fighting inflation have failed and they cannot afford to wait any longer? Of course, rein in the immediate cause for the price rise, or in other words, simply compromise on higher economic growth. The majority of the electorate is usually unconcerned about the rate of annual GDP growth, so long as prices do not rise.
Voters are not be too concerned if the growth rate declines from over 9 per cent to 8 per cent or even slightly lower. A percentage point drop in overall growth would not have any perceptible negative impact on an ordinary citizen. But, it would lower price levels at least modestly and the overall impact for a majority of the electorate would be positive.
That seems to be the government's thinking these days as well. For the last three years, the prime minister, finance minister and the planning commission deputy chairman have been maintaining that growth will not be compromised. Even when inflation started causing some trouble in recent months, they insisted that economic growth would not be sacrificed to cool down prices. That seems to have changed.
This week, two of the most respected officials, planning commission deputy chairman Montek Singh Ahluwalia and the chairman of the prime minister's economic advisory council C Rangarajan, who is a former governor of the Reserve Bank, have voiced their concerns about the 'overheating' in the economy. Till last week, nobody in the government had publicly used the term 'overheating'. In fact, some had publicly disagreed when the RBI said that the economy may have been growing too fast.
While Ahluwalia found direct correlation between rising inflation and the over 9-per cent economic growth, Rangarajan, the less political of the two, emphasised the need for addressing supply side problems.
Compromising on growth
Ahluwalia even hinted that the current growth rates may not be sustainable - the first time that a member of the economic 'dream team' of the present government has seemed doubtful about the sustainability of the recent trend of economic growth. Though Ahluwalia continues to insist that the target growth of 9 per cent per annum for the next 5-year Plan would not be lowered, he also knows that it is not such a sacred objective after all.
Central bankers often say that their main job is to manage 'inflation expectations' rather than inflation itself. It is now well accepted that prices do change according to the collective expectations of economic players both on the demand side and supply side.
Likewise, can the government actually manage 'economic growth expectations' and thereby remove part of the stimulus for higher inflation? The present government seems to believe so, though it appears to be overly optimistic about its ability to do so. Only time will tell if such optimism is misplaced.
If this indeed is a policy shift to lower growth targets, then it reveals the kind of policies we can now expect from this government for the rest of its term. It indicates that the talk of further reforms may be given a quiet burial, while producers are likely to be bullied to somehow lower their prices. Also expect more fiscal measures to control prices.
An even bigger danger would be more strident opposition from the Left parties towards government's economic policies. The myth of Left resurgence after the last general elections has been badly shaken in recent months. After the violence in Nandigram, the Left is probably facing their worst crisis in the last three decades in West Bengal.
In Kerala, factional fighting has led to complete government inertia, which has eroded much of the momentum from the landslide victory in assembly elections last year. Their attempts to maintain ties with regional parties in the Hindi heartland have failed and are now facing assembly elections on their own.
All these developments may force the left parties to mount stiff opposition to even half-hearted reform moves by the government. They have already made a start by shooting down the proposal to hike FDI in general insurance. Now that the government is also not very keen to push through such reforms, most sectors which were waiting for further liberalisation can forget about it at least till a new government is in place sometime next year.