The only real answer to inflation is to increase our internal production and thereby close the gap between the available supplies and the purchasing power in the hands of the community.” Finance Minister R K Shanmukham Chetty, presenting the first Budget on November 26, 1947.
India has consistently defied odds since its birth as a nation. Much has changed in the seven decades. The one issue that has been a constant in the history of independent India is its struggle with inflation. There has been no election, no session of Parliament, where it has not been an issue, and no budget where it has not been a concern. The observation of R K Shanmukham Chetty is just as valid in 2016.
Inflated expectations have been frequently deflated upon delivery—thanks to poor governance, definitions and approach. A deep, tragic irony stalks the financial sector—45 years after bank nationalisation and 25 years after
liberalisation. The biggest borrowers who account for the highest quantum and rate of NPAs pay the lowest rates and the poorest borrowers with much lower defaults pay the highest rates. The cascading effect has severely impacted public finances, the cost of public services and the price of capital for individuals in the economy.
Last week, the government entered into a statutory agreement with the Reserve Bank of India and fixed 4 per cent of CPI—plus minus 2 per cent on either side as tolerance—as the inflation target for the next five years. It could be seen as an ambitious target. It could also be argued that the government has been set up with a fait accompli. The fact is, annual CPI between 1960 and 2016 has averaged at 7.6 per cent—in 16 of those years, CPI has been in double digits and above 6 per cent in 35 of 56 years. Even in the post-1991 reforms era, CPI has averaged above 6 per cent for 17 of 25 years.
Yes, inflation has come down in the past two years. A fashionable assumption attributes the success to the muscle power of monetary policy. The question is how much of the dip is due to fall in crude and commodity prices? What part of the credit should we apportion to fiscal consolidation measures and to demand deflation—global and local? It would also be pertinent here to ask why the muscularity has not dented food or rural inflation.
The world over, there is recognition that monetary policy is at the intersection of the Peter Principle —it is poised on the brink of inefficacy. Post the 2008 global financial crisis, central bankers eased rates and introduced qualitative easing to achieve the 2 per cent inflation to boost growth. How many succeeded? The new wizardry is negative interest rates with similar outcomes—and this has led to accumulation of government and corporate bonds worth over $13.4 trillion with negative returns.
Objectively, the instruments of engagement for the RBI and other central bankers are similar and have scarcely changed. Assume that the government sticks to fiscal rectitude and conservatism. What are the tools with the RBI? It must juggle currency, liquidity and rates to manage the arc of inflation. Indeed, the challenge before the Reserve Bank of India is far more complex—driven by structural issues.
To appreciate the challenge, consider the composition of the CPI. The consumer price index comprises a basket of items broadly classified as food and beverages, paan, tobacco and intoxicants, clothing and footwear, housing, fuel and light, and miscellaneous. Food inflation accounts for 45 per cent of overall CPI (rural plus urban).
On Friday, India was informed that overall CPI had touched 6.07 per cent and food inflation had spiralled to 8.35 per cent. The simple math is that nearly half the rise in CPI was accounted for by food inflation. The harsh truth is that monetary policy has little or no effect—bar on the margins—on food inflation. In effect, borrowers are paying the price of poor governance across states.
Classical theory says that inflation is confiscation of wealth, an undeclared tax, and affects the poor the worst and rural India hosts the bulk of the poor. In India, rural inflation is higher than in urban areas—for transport, education, health, clothing, fuel and even cereals. It symbolises the inefficacy of monetary policy. It is also a reflection of the structural challenge of unbanked, poorly connected cash-driven, informal character of the rural economy.
There is no question that the cost of capital must come down. Sometime this month, a new RBI governor will be appointed. The ensuing discourse will borrow phraseology from ornithology. Hawk or dove, the RBI and governor can do only so much—perhaps reassess the target, redefine the gobbledygook, that is the marginal cost of lending, and speed up opening banking to specialised capital and solution providers.
Real acceleration of change will need to be driven by intervention, innovative government policy—a la Mudra, which is good but not enough. Those engaged in agriculture—the largest private sector with the largest workforce —are denied customised credit and charged usurious rates. Tractor buyers pay higher rates than car buyers. Asset-backed mortgage rates for home buyers can and must be brought down.
The crux is that there is a large segment of savers and borrowers about whom the system knows little. The problem is not unique to India—the Tiger economies, China and economies in Latin America have harnessed technology, innovated public finance policies to bridge the gap for those at the bottom of the pyramid. This demands the creation of an info network on consumption and savings that specialised financial institutions can use to assess opportunities and risks to expand aggregation of savings. The fundamental challenge is to create access and affordability and this can be enabled with technology—the many payment systems, Aadhar and mobiles must be brought into play.
The current state of dysfunction in the financial sector is not sustainable—for efficiency and equity.
The writer is the author of Accidental India: A History of the Nation’s Passage through Crisis and Change
shankkar.aiyar@gmail.com