The Hindu Business Line : Fiscal profligacy, cause of inflation

With the wholesale price index (WPI)-based inflation climbing to a 16-year high of 12.63 per cent for the week-ended August 22 from 12.4 per cent in the preceding week, there is a sense of panic in official circles. In a desperate bid to rein in prices, the government has decided to unload surplus stocks of wheat and rice in the open market.

While the rate of inflation has been climbing relentlessly over the past few months, what is surprising is that there has been no serious effort on the part of the policy-makers to find out the root cause of the disease before deciding on a strategy to deal with it.

DOMESTIC FACTORS

Domestic price rise is not due to external factors alone, as the government would have us believe. Only a small part of it is on account of the rise in the international prices of crude oil and other commodities. If the major cause was the external prices of commodities, the recent easing of oil, commodity and food grains prices should have reflected in inflation numbers released in recent weeks.

According to the figures released by the Government’s chief economic advisor, Arvind Virmani, between July 2007 and June 2008, while global food grains prices rose by 45 per cent, their domestic prices rose by only six per cent.

Over the same period, while world oil prices had shot up by 93 per cent, the domestic prices had risen by only a fraction of that. Only the domestic prices of edible oils and minerals had increased significantly during the period.

Supply-side factors have contributed significantly to the current inflationary pressures. At the retail level, the prices of food grains, vegetables, and so on, have shot up significantly despite the bumper production this year. Unfortunately, the supply chain management on the part of the government has been abysmally poor and the country’s public distribution system (PDS) has failed to provide the much-needed food security to the millions of poor in India.

The entire system is riddled with corruption and poor governance. A study conducted last year had put the number of bogus ration cards in the country at a staggering 2.3 crore. And, according to a recent Lok Sabha Public Accounts Committee report, of 14.07 million tonnes of food grains released by the Food Corporation of India, only 5.93 million tonnes had reached the targeted families.

RECKLESS DEFICIT SPENDING

The root cause of soaring inflation, however, is the reckless deficit spending that the Centre has resorted to over the past two years. The real deficit numbers have been hidden by ingeniously pushing quite a few large expenditures as off-balance-sheet items.

There has been a frequent resort to the issue of bonds to oil marketing companies (OMCs) and fertiliser companies towards compensating a part of their uncovered losses.

This year, the value of oil bonds issued to state-owned OMCs has amounted to Rs 94,604 crore taking the government’s oil bonds issuance tally to Rs 1,65,000 crore over the last four years.

In addition, fertiliser bonds worth Rs 95,000 crore would be issued this fiscal. The total fertiliser subsidy Bill this fiscal has now been pegged at a mind-boggling Rs 1.19 lakh crore, of which only Rs 30,985 crore has been budgeted.

The bonds have a tenure ranging between nine and 15 years and the government will have to spend an additional Rs 10,000 crore per annum on servicing these two bonds, thus passing on a substantial burden to future years. In addition, the bonds issued under the RBI’s market stabilisation scheme will involve an interest outgo of Rs 13,958 crore this fiscal.

In addition, the politically motivated farm loan waiver scheme, worth Rs 60,324 crore, announced in the Budget and, subsequently, expanded to Rs 71,680 crore, will certainly strain the government finances further. It may cost the government around Rs 25,000 crore in the current year.

Also, the Sixth Pay Commission award for the Central Government employees announced recently will involve a cost of Rs 30,062 crore. Very soon, many State governments are also expected to extend the benefit of this award to their employees.

Not surprisingly, the latest report of the Prime Minister’s Economic Advisory Council (EAC) has cautioned against the off-budget liabilities.

It has contended that all these would amount to as much as five per cent of the GDP in 2008-09 in addition to the budgeted fiscal deficit of 2.5 per cent of GDP. Thus, the real fiscal deficit of the Centre will shoot up to 7.5 per cent of the GDP and the combined fiscal deficit of the Centre and the States together, is expected to touch 10 per cent of GDP this fiscal.

ADVERSE CONSEQUENCES

The adverse consequences of this fiscal profligacy are already visible to all observers of the country’s economic scene. The most obvious consequences have been the relentlessly soaring inflation and the rising interest rates following the frequent resort to monetary measures by the RBI to fight inflationary pressures, resulting in a moderation of economic growth.

The RBI’s monetary measures to control inflation have become ineffective because of the unacceptably high fiscal deficit and a lack of co-ordination between the monetary and fiscal policies.

Instead, the relentless monetary tightening by the RBI in recent months has only started hurting economic growth if the first quarter growth of the index of industrial production (IIP) is any indication. The cumulative IIP growth during April-June this year has plummeted to 5.2 per cent from 10.3 per cent last year.

According to the Economic Outlook for 2008-09 prepared by the Prime Minister’s EAC, India’s economic growth is expected to decelerate to 7.7 per cent during the year from 9 per cent in 2007-08 and 9.6 per cent in 2006-07.

In fact, some economists expect the GDP growth during the current fiscal to come down to 7-7.5 per cent.

According to some experts, the concern about growth slowing down may be not so much for 2008-09 but in 2009-10 and beyond. Corporate India is still flush with funds, thanks to the robust profitability in the past three years. But this year, there are clear signs of margins coming under pressure. While India Inc had raised more than $ 70 billion in 2007-08, the amount raised during the current fiscal so far is just around $4 billion.

Evidently, there is an urgent need to have a re-look at the FRBM Act and plug the loopholes to prevent the resort to off-balance-sheet items, including the borrowing by the public sector undertakings (PSUs).

There is a need to ensure complete transparency in fiscal deficit numbers to put an end to fiscal mismanagement with all the attendant adverse consequences.

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