The Hindu Business Line : Inflation tiger and Government deficits

For the inflation that is currently raging in India, one of the explanations being advanced is that it is a global phenomenon, and India, with its globalised economy, is paying the price. Lately, there has also been more awareness about the speculation in commodity prices, which has been allowed through the euphemistically termed “commodities futures” (we already have Mr Montek Singh Ahluwalia insisting that this variety of speculation must go on).

But what is surprising about the ongoing debate on inflation is the complete absence of any talk of the role of government deficits, their contribution to the growth of money supply, and its consequences. We did experience in the 1960s and 1970s that government deficits led to consumer price inflation, and that acted as a check on the government’s temptations to print money at will.

But this consideration was discarded in the early 1990s (when Dr Manmohan Singh became the Finance Minister) and there was unabashed resort to deficit financing. In the current year, 2008-09, about 25 per cent of government expenditure will be met by deficit funding.

Until recently, the excess money supply was rushing only into shares and real-estate, and we had asset price inflation. But the chattering classes were mostly happy, thinking that we are all becoming rich. Of late, the money is also going into commodities, especially food grains, and driving up their prices. This is having a different impact.

It is, however, an established fact that government deficits lead to increase in money supply and a natural consequence is inflation. In the current economic jargon, government deficit is explained away as a percentage of the GDP, and the Indian public apparently accepts this version without a bat of the eyelid.

We must pay attention to government deficits and assess their impact on inflation if we are serious about understanding its causes and finding remedies.

P. M. Vasudev Auckland, New Zealand