The Hindu Business Line : Inflation fighting — Learn from Chinese experience

Those who always cite the Chinese model for economic and social management have ignored the inflation experience of China. India cannot be an exception to the rule that global prices are on the rise. Only by increasing supply can food and other prices be controlled.

S. Venkitaramanan

There have been threats of agitations and fiery speeches against Government’s alleged inaction in preventing price rise, which has admittedly reached a high of 7 per cent plus. The explanations of the Finance Minister and other authorities are that the price rises in India are consequences of such global phenomena as a rise in crude oil prices, increase in wheat prices and higher corn prices as a result of large diversion of corn to bio-fuel, and so on.

These explanations have not carried conviction amongst the Left members of the UPA. The fact, however, remains that the Government is not in a position to influence these prices, which have risen as a result of supply and demand at a global level.

In order to counter imported inflation, the Government has resorted to a number of fiscal measures, such as reduction of Customs duties on essential items like edible oils and other commodities. While the immediate consequences of these actions may be an alleviation of price pressure, these measures also have a certain long-term consequence, in that they make the Indian producers of these commodities less willing and less incentivised to grow these crops.

There is a need to balance the considerations between inflation-fighting and self-reliance. The latter is bound to be most successful in a country less vulnerable to international price shocks, as in the case of wheat and edible oils.

Imported inflation

There have been repeated calls for Reserve Bank of India action to counter inflation. It is well-known that Milton Friedman’s supporters have argued that inflation is, at all times, a monetary phenomenon. But this has apparently been subsumed by the turn of events, where the sheiks of Arabia and the oligarchs of Russia determine the price for oil and gas, turning on and off the supply if the oil price does not reach their target.

It is imported inflation that is at the heart of the current inflationary spiral. What can the central bank do in the ensuing Credit Policy to control these global prices?

There have been strong advocates of monetary tightening, such as through an increase in the CRR or repo rate, although they find it hard to explain how such gestures on Mint Street will affect the price of crude or of wheat in the Australian market or on the Chicago Mercantile Exchange. But such are the ways of conventional monetarists that the signs of the incidence of inflation leave them with no option but to think of tightening monetary policies, with little care for the consequences on growth.

Although money supply itself may not be able to effect supply responses, tightening of monetary policy can have an adverse impact, which the policy-makers may like to avoid. Increasing interest rates in India at a time when the world as a whole is tending to a more benign interest rate regime might invite the flow of funds from abroad, which will contribute to worsening the problem the authorities intend to solve.

To the extent to which monetary tightening increases the flow of liquidity from abroad, policy-makers might find themselves in a dilemma that their measures, which increase capital inflows, turn out to be inflationary. This is a problem the RBI, hopefully, will try to resolve by calibrating its interest rate measures appropriately. These should just be sufficient to restrict consumption but not increase capital flows. This is a difficult task at all times.

The Chinese scene

Be this as it may, I leave it to the mandarins of North Block and the wise men of Mint Street to balance their various considerations. The fact remains that India is not alone in having higher figures of price increase. A recent issue of The Economist (March 21, 2008), carries an interesting article titled “The Sweet and Sour Pork”. It focuses on Chinese inflation. It points out that the Chinese inflation rate in February 2008 reached a 12-year high — 8.7 per cent.

When China’s supposedly efficient system of public distribution and mandatory control has not been able to keep in check inflationary levels, how can the protagonists of the Left argue that India has not been able to contain inflation, even though it is at 7 per cent, lower than China’s 8.4 per cent?

It is true that China is doing its best to manage inflation through monetary methods also. But food prices have climbed in response to global factors and the Chinese recognise that it is not possible to lower them merely through monetary measures. The Chinese experience should be a lesson for our own policy-makers as to how far they can act on money supply measures.

It is surprising that those who always cite the Chinese model for economic and social management have ignored China’s inflation experience. India cannot be an exception to the rule that global prices are on the rise. There can be only one method of controlling prices of food and other materials. That is by increasing supply, which will, however, take time. This is apart from better public distribution and eliminating leakages in the supply channel.

Rupee appreciation

A suggestion has been made that appreciation of the rupee can have a significant impact on the price level. To some extent, this is true. This is because appreciation of the rupee reduces prices, as perceived by the Indian consumer, of imported commodities. But, against this, rupee appreciation has an adverse consequence, to the extent it makes imports cheaper, local producers are affected. Further, it makes exports less attractive.

Much has been written about the destabilising consequences of appreciating rupee. I hope the RBI will consider carefully the social and economic consequences of its present policy of allowing the rupee to get stronger. In a recent article, economist Dr Surjit S. Bhalla had explained how the effects of rupee appreciation or of any rising currency cannot, by itself, bring down inflation in an economy such as ours.

The point at dispute is not only about whether the country’s economic policy can influence global factors sufficiently to make a difference to the domestic price level. The answer from the Chinese experience is that such domestic policies can have very little impact in this regard. Inflation today in India reflects a global phenomenon. Above all, money supply can do little to mitigate it when it is governed by supply-side factors.

Dose of realism

A dose of Chinese realism is called for to assuage the angst of the protestors, who are taking steps to destabilise the UPA by alleging that the Government has failed on the price front. If the Indian Government has failed on the price front, so also have the Chinese authorities.

While two wrongs do not make a right, the increase of price in one part of the world impacts the economy whether it is Indian or Chinese. The response to the problem should be pragmatic and should be directed towards increasing and improving the supply-side responses in India by enhancing the productivity of the economy. Merely protesting that India has not been able to control global inflation is populist, but counter-productive.