The Hindu Business Line : Money matters, but not alone

Inflation is a monetary phenomenon. The monetarist central bank follows this belief religiously with the assumption that there is always full employment and, in this situation, any increase in money supply results in an equal increase in the inflation rate.

Alternatively, in the context of a less than full employment situation, when money increases at a higher rate than the real output growth rate, inflation rate rises proportionately. Hence, the Reserve Bank of India has raised either the cash reserve ratio (CRR) to contain monetary growth or hiked the interest rate to increase the cost of money and finally contract demand for it, and thereafter demand for goods and services.

For instance, in April 2008 the CRR was pushed upwards twice, from 7.5 per cent to 8 per cent and further to 8.25 per cent. From December 2006 to end-April 2008, the RBI raised the CRR almost ten times to curb inflationary pressures but, to our disappointment, inflation has been soaring ever higher, from 5.5 per cent as on December 23, 2006 to 7.35 per cent as on April 30, 2008, on top of several mitigating measures, including import of food items and restrictions on exports of foodgrains and edible oils.

On April 29 last, the RBI rightly avoided repo interest escalation. During the course of professional discussions on inflation and its link with excess liquidity in market, the feasibility of raising interest rates was recommended. However, the point lost sight of was that an increase in the rate of interest escalates cost of holding money and reduces the demand for real money balances.

The higher interest rates would have encouraged and compelled households and businesses to have more money to protect their purchasing power, else the consequences would have been worse in terms of fall in demand for goods and services and finally resulting in less production and employment, but without reducing the demand for food.

Monetary suppression

Perhaps, this time, the monetarists are not responsible for scaling up prices or inflation. Monetary suppression is not the right tool to tame inflation. Similarly upward interest rate pressure would have not been logical solution. The cause of sustained inflation is increases in food consumption by the people who have crossed the poverty line.

Million of households are likely to have crossed the poverty line during the past decade. Of course, sluggish agricultural performance could not match this improvement in the standard of living of people, who were either starving or eating only once a day. It is thus clear that inflation today is not a monetary problem, but has arisen from a shortage of foodgrains, edible oils, fruits, eggs, and so on.

It is a misallocation of resources at the national level depriving agriculture of adequate investment and lack of rural infrastructure, such as irrigation facilities, power shortage, inadequate and costly fertilisers, etc. It is strange that the economy has huge liquidity, despite crores of people going without even a dollar a day.

In the last 20 years, no major development has taken place on the agriculture front. Farm investments by been largely overlooked by the government, both the present as well as the past. There has not been any serious public discussion by the Planning Commission on the future of agriculture.

In fact, no government agency has been able to estimate the food requirement for next 50 years. Professionals, media and government institutions and big business houses have been busy with India Shining and such other slogans. It is painful to reflect that when the US started shining it supplied food to whole world under PL-480 and when India is shining, a third of its population goes without proper food. Even several decades after the Green Revolution, situation continues to be grave.

The Government has to now help augment food supplies through quick supply of fertilisers, agriculture inputs and micro irrigation equipment to farmers and provide bank finance at concessional interest rates.

In the long run, the Government should divert resources to promote power projects for rural sectors, and import sufficient quantities of fertilisers and high-yielding varieties of seeds. Moreover, fertile farmlands should not be diverted to non-agricultural uses. The cropping pattern should be shifted in favour of foodgrains, including pulses.

(The author is Chairman Madhya Pradesh Stock Exchange Ltd.)

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