Fiscal policy and inflation

| Updated on: Jun 17, 2011

It's time the Centre took over the baton of reining in inflation from the RBI because it is better equipped to yank the economy out of the slowdown fears that have gripped it.

Monetary policy seems to have run its course as far as fighting inflation is concerned. The ten rate hikes since February 2010 have been unable to curb inflation even as they set up the environment for a slowdown in the economy. Manufacturing growth was 5.5 per cent in the fourth quarter of 2010-11 against 15.2 per cent in the corresponding period in 2009-10. We now have the worst possible combination staring at us — that of stubbornly high prices, particularly of food, and the prospect of reduced incomes. While it is true that food inflation has been a problem of supply bottlenecks and other market imperfections quite beyond the scope of monetary policy, inflation has now spread beyond ‘headline' to ‘core' items.

New Delhi now needs to take the initiative; it is better equipped to yank the economy out of the slowdown fears that have gripped it. Intelligent fiscal policy is the need of the hour, one that pursues fiscal consolidation so that private sector is not ‘crowded out', without, however, squeezing out the demand impetus that industry sorely seems to need at this stage. Let New Delhi not make the mistake of the US and EU of choking funds to the economy when a timely demand injection is what it perhaps needs. Intelligent fiscal consolidation means that less money be used to achieve the desired outcomes. For all its seeming lack of direction, the government has made a beginning in this area. The setting up of the Nilekani Committee to implement direct cash transfers in the case of LPG, kerosene and fertiliser subsidy is a step in the right direction. The need to “explore alternative models of subsidy delivery” to the PDS was made in a recent letter by 35 economists to the Chairman of the National Advisory Council, Ms Sonia Gandhi. Instead of distributing subsidised grain through PDS, where only 10 per cent of the subsidy according to studies reaches the “poor”, direct cash transfer through a smart card network can ensure wider coverage at the same or lower cost.

While pruning the fisc and keeping a watchful eye on the Rs 1.5 lakh crore subsidy bill on account of fuel, food and fertiliser, it should be kept in mind that high food prices, or reduced access to food, are a recipe for social and political instability in a country where the average person spends half his income on food. The country is home to the largest number of malnourished people. Expenditure reform will have to be a calibrated, medium-term exercise, given the prevailing socio-economic realities. Whether one likes it or not, these changes do not happen in a hurry.

Published on June 24, 2011

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