Interest hike and liquidity curb are futile exercise for controlling inflation in India. Key role should remain with government and not with RBI.
Inflation has been a cause of constant worry for all Indians. Middle and poor class are the real victims. Its impact is severe when there is no matching income growth. Headline inflation (WPI) is nearly on double digits for three years. Consumer inflation is still higher. Price of energy, vegetables & food items has become un-affordable. States are passing the buck to the Center. In turn, central government is shifting the responsibility to RBI that has limited option of interest hike and liquidity curb. Truth prevails; there is no link between inflation and interest rate in the Indian context. Interest hike doesn’t reduce demand or promote financial savings unlike developed countries. This is due to low income base here. Yes, this can kill growth in National income and then reduce demand that we are presently facing. This can slow down investment, increase debt servicing cost and increase production cost of entire goods & services. We must therefore make right diagnosis for treating this disease, instead adopting a proto type approach.
Right steps are to cut supply deficit, achieve higher productivity, improve cost efficiency and craft competition. Fiscal expansion for consumption expenditures is another big reason. Monetary expansion arising out of non-productive income needs to be curbed. High growth, good infrastructure and regulatory easement will provide real solution. We must improve economic efficiency of the country that depends upon policy and regulations. These actions will certainly cool down Inflation and reduce trade deficit also. Both are interlinked to a large extent.
Probably the concept of using monetary tools for controlling inflation has been adopted from developed countries. Per capita consumption in those countries is at peak. Demand growth is driven through consumer finance that is closely linked with interest rates. Consumer loan portfolio is too high compared to India in terms of GDP per cent. Any interest hike in these countries will reduce demand and cool down inflation.
Indian conditions are altogether different. Per capita consumption is quite low. Consumer demand is bound to grow here with rising income. Cutting demand growth will not be a right solution. Therefore, we should increase supply through higher growth and low inflation. Whereas, the current scenario is just reverse with low growth and high inflation similar to Stagflation. It is indeed a dangerous situation. There is no rationale for adhering to a failed concept of hiking interest rate that is evident from our past experience.
We must overcome supply deficit through higher production of goods and services. We should not opt for importing and bridging supply deficit on regular basis. This will multiply our problems. At the first instance, we must ensure higher productivity from the existing productive sector in operation. Simultaneously, closed plants & mines may be restarted before they become permanently sick. Regulatory easement may be extended for entire product sector. All productive assets are national assets irrespective of management control. We can’t afford keeping them idle. Unless, existing investments are performing well, fresh investments may not be executed for building new capacities. Unless we take care of domestic investors and entrepreneurs, FDI will be simply a mirage.
Agro sector is hungry for investment and technology. Agro producers do not have enough capability to invest. Therefore, both State & Central government must play key role for investing in agro infrastructure and technology. Perishable goods such as fruits, vegetables and milk need cold supply chain and processing facility. Suitable policy may be framed for the entry of private corporate for sharing such investment burden.
Currently, Investment capital output ratio (ICOR) is exceeding 6.0 that was below 4.0 during 2008-11. This speaks of low economic efficiency in terms of output vis-à-vis capital investment. Economic efficiency depends upon entire gambit of policy & regulations and not limited to producers alone. Can we afford such high ICOR in a capital-starved country? High interest and low ICOR is indeed killing the Indian economy.
Higher production alone is not sufficient for controlling the inflation. We must ensure that cost of production and delivery of goods & services are reasonably low. Production cost of any goods depends upon the cost of basic inputs such as Energy, Minerals, Capital, Labour and Logistics those are at record high. These inputs can be economized through regulatory easement and massive investment. Once, these are under check & enough production capacity is built up and higher productivity is ensured; there is no reason for Inflation to sustain. Yes, monopoly and cartel formation must be ended by crafting competition among producers.
Despite these steps if money supply exceeds availability of goods & services; it can set Inflation in the system. If money supply is due to increase in productive income (GDP), supply and demand gap as a whole will match except for a few items. This may cause temporary inflation in those items that will nullify in due course. However, Government Subsidy and Investment income out of sale of asset are non-productive income. Receipt of such income is without any production of goods or services. This will obviously cause mismatch in overall supply & demand and invite inflation to some extent.
This can be controlled only by the government since RBI does not have any controlling tool for it. Therefore, subsidy must be under check and government should replace consumption expenditure by infrastructure spending. Investment income by public should be re-invested in financial savings through fiscal incentives. We must discourage deployment of such non-productive income for consumption that will invite inflation.
Once we succeed on these fronts then inflation shall certainly remain below 4 per cent that was prevailing in FY02 & FY03. At the same time, GDP growth shall take a leap jump. In such a scenario, trade deficit will radically reduce and Rupee-Dollar conversion shall stabilize. We must reduce interest rate and control inflation by these methods that will set examples for others. We must be trend-setter and not a follower. Let us not blame global scenario for our own misdeeds. Rather, we should set our house in order and unlock hidden potential of our nation.