Limits to anti-inflation agenda

The world economy is facing an unprecedented phenomenon of persistent high inflation. It is a problem common to the developed world and all high-growth emerging economies, including India. China, too, has been dealing with indomitable inflationary pressure, and the authority there is almost at its wits' end as to what more it can do to contain inflation. It has apparently exhausted all monetary measures, and yet CPI inflation in China is hovering at around 5.5 per cent. Today, inflation is essentially a problem associated with growth.

With prices moving incessantly northward, many central banks, like ours, seem to have decided that enough is enough, and inflation control must be given priority over growth, which they feel can be sacrificed. This is where we need to reflect a bit, before it is decided to kill the growth momentum. It has never happened that so many economies are on the growth path at the same time. The world economic order is changing rapidly. The North-South divide has already disappeared, and what we see instead now is emergence of a new divide between the advanced economies and the emerging market economies (EMEs), which are fast-moving and demand-inducing.

The significance of the latter lies in the fact that, with the advanced economies faltering, only the EMEs can propel the world economy. It was the EMEs which had helped the world economy out of the crisis. But now the problem of inflation in the EMEs is threatening the outlook for world economic recovery.

DEMAND-LED INFLATION

The five year period 2003-07 was a one of high growth for world economy and trade. While world output had grown at annual average rate of 5 per cent, world trade volume was growing at near 8 per cent. It was during this period that the phenomenon of emerging economies was first observed. The end of the period had, however, witnessed sharp and unprecedented surge in commodity prices, including oil that had almost reached $150 a barrel.

The financial and economic crisis of 2007-09 was a kind of blessing in disguise, in the sense that it eliminated the upward trend in commodity prices by puncturing world growth. On the negative side, the emerging economies too had gone into crisis mode.

In 2009, EMEs had recorded a collective growth of only 2.4 per cent, and the world GDP had actually declined by 0.6 per cent. In 2010, the EMEs recovered and recorded a growth of 6.3 per cent in GDP, but the recovery brought back food and commodity price inflation. An additional factor this time has been political upheavals in the Arab world that have pushed up oil prices.

Massive adoption of market-oriented economic reforms in countries belonging to erstwhile ‘South' have given rise to the new breed of emerging economies, which could be called fast-moving high and medium-growth economies. During 2003-07, such economies put together, led by China and India, registered an average annual growth of 7.5 per cent. An obvious outcome was a rapid increase in commodity and energy prices, which had then translated into increase in prices of finished products.

The CPI inflation in EMEs had risen to 9.2 per cent in 2008, up from 6.5 per cent in 2007. The fact is that the EMEs are easy prey to demand-driven inflation in their drive for growth. The demographic structure in such economies is yet another factor contributing to inflationary pressure. As such, growth means reduction in poverty, and hence rising demand for food (leading to food price inflation). Besides, the bulk of the population is young.

In the non-OECD countries, for instance, more than half of the population is below 25 years of age. Also, note the burgeoning number of middle-class population in all the EMEs. Further, many of the EMEs have population growing at around 2 per cent a year or a little less. Implications of these factors for demand-side scenario are only too obvious.

The EMEs are huge demand volcanoes, waiting to erupt. When this is the case, supply-side uncertainties are bound to grow, more so if growth is hampered in pursuit of inflation control. Given the situation, it is obvious that actions on the part of central banks to curb inflationary pressure are bound to be of limited relevance at this stage, but run the risk of denting growth badly.

COORDINATED ACTION

Solutions to the problem of inflation versus growth have to be found beyond the purview of monetary policy actions. There is a need for more coordination and cooperation among EME governments. If the EMEs lose their growth momentum, the prospects for world economic recovery would recede.

Economic recovery in the advanced economies looks doubtful at this stage, but if the emerging economies also go down the path of slower growth, then, not only will the world economy suffer prolonged recession, but the incidence of poverty will also dramatically increase, giving rise to many other problems that come with growing poverty and rising unemployment.

(The author is President, JK Organisation. The views are personal. >blfeedback@thehindu.co.in )

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