INFLATIONARY TREND – IS IT DEROGATIVE OR A DECORATIVE MATINEE?

The post liberalization has created a positive atmosphere for a steady growth in certain sectors and a disturbing growth in certain other sectors. While the growth in education sector is 3.5%, in higher education it is less than 2% in insurance sector it is 2%, but the growth in Infrastructure and in real estate construction is 60 to 70%, which is a phenomenal achievement, this will develop 269 industrial sectors. This will facilitate and enhance the purchasing power and disposable income of individuals working in the sector, and as a corollary savings, investment and expenditure in consumer households will increase. Inflationary trends is a healthy sign in a growing economy but it has to be added like a salt, too much of it will dampen the economy and too little of it will create a debt trap. India suffered debt trap in 1991 and various measures it has crawled to reach this stage. Hence the debate is to add this salt of inflation to which of its recipes and at what stage remains to be seen since an unresolved issue is like still water which is deep.

"Unemployment and inflation still preoccupy and perplex economists, statesmen,
Journalists, housewives, and everyone else..."

James Tobin

Economic growth, inflation and unemployment are the three big topics of Macroeconomics. Explicitly embodied in legislation in India and other countries are the goals of achieving rapid economic growth, a low rate of inflation and a low rate of unemployment.

INTRODUCTION:
Price stability has been an important objective of monetary policy in India. Compared with many developing economies, the Indian inflation experience can be considered satisfactory, despite recurrent supply shocks and continuing fiscal imbalances (Reddy, 1999). This is attributed to relatively better monetary management coupled with judicious supply management through buffer stocks of food grains and imports of sensitive commodities which contained the adverse effects of supply shocks and reined in inflation. Nevertheless, inflation increased during the 1970s and remained high thereafter till mid-1990s. In the period since 1996-97, inflation has edged lower reflecting concerted policy efforts.

Annual rate of inflation measured by variations in the wholesale price index (WPI) over the past five decades averaged 6.6 per cent in India. Inflation was very low during the 1950s averaging 1.7 per cent, but was quite volatile and annual inflation ranged between (-) 12.5 per cent and 13.8 per cent. The volatility was mainly on account of agricultural failures. Inflation accelerated to 6.4 per cent during the 1960s partly induced by the two wars during 1962 and 1965 and crop failures in 1965-66 when agricultural production fell by more than 16 per cent.

Inflation accelerated further during the 1970s due to both supply and demand shocks. The supply shocks emanated mainly from oil and food prices. In line with the sharp increase in average international crude oil prices by over 250 per cent in 1974, domestic fuel prices increased sharply from an annual average of about 4.7 per cent during the three years preceding the first oil crisis to about 26.5 per cent on average during the three years beginning 1973-74. The adverse impact of the oil price shocks got accentuated by the drought conditions in 1972-73, 1974-75 and 1979-80 which resulted in significant declines in agricultural output. Thus, higher fuel prices and agricultural commodity prices got reflected in overall inflation. Sharp increases in money supply - even as output growth decelerated during the 1970s - added to demand pressures. Consequently, inflation moved up further in the 1970s, averaging about 9.0 per cent.

During the 1980s, demand pressures emanating from an expansionary fiscal policy and its monetization coupled with irregular supply shocks kept inflation high. Inflation averaged 8.0 per cent per annum during the 1980s, somewhat lower than that of 9.0 per cent per annum during the 1970s. Fiscal deficit of the Centre widened from 3.8 per cent of GDP during the 1970s to 6.8 per cent during the 1980s. A large part of this burden was borne by the Reserve Bank - almost 32 per cent of the fiscal deficit was financed by the Reserve Bank during the 1980s (25 per cent during the 1970s). Monetized deficit almost doubled from 1.1 per cent of GDP during the 1970s to 2.1 per cent during the 1980s. Consequently, the net Reserve Bank credit to the Centre expanded by 20.0 per cent per annum during the 1980s as compared with 14.5 per cent per annum during the 1970s and this led to acceleration in reserve money growth. Broad money growth could however be contained to rates lower than the 1970s, as a result of increases in cash reserve requirements.

Inflationary pressures accelerated in the first half of the 1990s. High fiscal and current account deficits of the 1980s culminated in the balance of payments difficulties during 1990-91. As part of the macroeconomic stabilization programme and structural reforms undertaken in the aftermath of the crisis, exchange rate depreciated substantially. Between end-March 1991 and end-March 1992, the Indian rupee depreciated by nearly 37 per cent. Notwithstanding the limited openness of the Indian economy, this order of depreciation added to inflationary pressures. The exchange rate depreciated by more than 11 per cent per annum during the first half of the 1990s; almost double that during the second half of the 1980s. Hikes in procurement prices as well as supply-demand imbalances in essential commodities like pulses, oilseeds and edibles oils further added to inflation. A part of the hike in procurement prices was intentional so as to restore the terms of trade for agriculture. Primary articles inflation accelerated to 18.1 per cent in 1991-92 from 13.0 per cent a year back. Extremely low foreign exchange reserves - foreign currency assets at US $ 2.2 billion at end-March 1991, equivalent to less than one month of imports -constrained the ability to import to meet the demand gaps. The sustained rise in fuel prices at a double-digit rate (of about 13 per cent) in the first half of the 1990s had its impact on inflation not only directly, but also in other indirect ways.

POST LIBERALIZATION:

We all know that after the liberalization of the Indian economy in 1991, our Indian economy is witnessing a sea change. The major two problems faced by our country are the population and the BOP deficit. Before 1991 our BOP deficit touched the astronomical figure of 16, 900, 34 crores. By keeping in view the situation of crises the new economic policy which was the combination of Globalization, Privatization and liberalization was introduced. The main objective was to make the economy more competitive and to increase the exports and Industrial efficiency.

There are many positive aspects of this policy like there was a considerable increase in the Foreign Exchange Reserve, India’s foreign exchange reserves have grown significantly since 1991. The reserves, which stood at US$ 5.8 billion at end-March 1991 increased gradually to US$ 25.2 billion by end- March 1995. The growth continued in the second half of the 1990s, with the reserves touching the level of US$ 38.0 billion by end-March 2000. Subsequently, the reserves rose to US$ 113.0 billion by end-March 2004, US$ 141.5 billion by end-March 2005, US$ 151.6 billion by end-March 2006 and further to US$ 165.3 billion by end-September 2006 and Indian economy witnessed a drastic growth rate.

We all know that growth is actually not possible without Inflation. There exist a direct relationship between growth and Inflation. Therefore to achieve a growth rate of 8 to 9 % we have to bear the considerable rise in inflation also.

Our Indian economy can be broadly classified into two categories (i.e.) the Urban and the Rural population. Around 70% of the Indian populations are still living in the rural and around 65% of the entire Indian population is still dependent upon agriculture and their contribution to GDP is around 17 to 18 %. It is very much evident (i.e) (65% of the population contributing 18% to the GDP) that there exists an extreme situation of underemployment or disguised unemployment.

We noted earlier that the entire population is bifurcated in 70:30 ratios. We also saw that the growth has to be accompanied by inflation. So the major problem is that 30% of the population which is reaping the benefits of growth is not affected or least affected by inflation on the other hand the rest 70% of the population which does not reap the benefits of growth is very badly affected by inflation. Till today the average wages of an agriculturalist in states like U.P and Bihar is just Rs 5 per day. So how are these poor people going to manage the effect of inflation? How are we going to control the increasing rate of farmer suicide? These questions remain unanswered.

According to National Council of applied Economic Research, 350 million of the Indian population, live in the state of acute poverty. Another disturbing fact is that out of the 40% poor the poorest 20% have a daily income of Rs 3 and the remaining 20% have a daily income of Rs 5.5.

The agricultural sector has been the hard hit. In the pursuit of Invitation, Accommodation and Entertainment of the M.N.C’s we have become indifferent to the most crucial sectors of the economy (i.e.) the rural infrastructure and agriculture then the problem of drinking water, education and health in the rural are still in pursuit. The number of farmer’s suicide is the measure of the widening income disparity.

The drive figure of Sensex or the increase in the growth rate cannot give a relief to the poor and the down trodden society which is the majority in case of Indian population.

There is a drastic decline in the capital formation in the agricultural sector, the total public investment in the agricultural sector war Rs 4467 crore during 93-94 which has come down to 2549 Crores during 02-03.

The large section of the society or the population which is living outside the charmed market is being continuously persuaded for the slow moving trickle down effect. In a country like India where 70% of the population which is not in a position to reap the benefits of growth, the finance ministry and the central bank should concentrate to keep the inflation under control in order to protect the interest of the majority of the population.

Generally we often see the minority fighting for there well being and protection but in our country the majorities interest is not being protected.
Inflation Vs Unemployment

It is pretty evident that unemployment level is dependent upon the real GDP to a great extent. Real GDP growth is not possible with a strict monetary policy. If the Government is much concerned about containing Inflation in the short run then it has no other option rather directing the RBI to hike the Interest rates and to follow a strict monetary policy which implies low demand for money and low investment by the corporate which will hamper the real GDP growth, as a result the unemployment rate will increase to a considerable level. Real interest rates may be seen as a measure of the cost of capital. Higher real interest rates are expected to slow down economic activity since capital costs increase which leads to lower investment eventually decreasing employment.

This is the main reason why majority of the economists feel that Inflation is much better than deflation, in fact Inflation fuels the engines of growth.

Now let us take a look at some important facts:

Ø Inflation in India is mainly due to Demand pull factors.
Ø The aggregate Demand is more than the Aggregate supply which obviously leads to Inflation.
Ø Inflation can be curtailed by increasing the interest rates i.e. by following a tight monetary policy, but such tight monetary policy can hamper growth and may lead to disastrous consequences.
Ø Increase in Interest rate would lead to decrease in borrowing by the Industries.
Ø Decrease in the borrowing by the Industries will hamper the expansion plans.
Ø If there is no expansion by the Industries the Aggregate supply cannot be increased and as a result this situation will again create Inflationary pressure in the Economy.

The above mentioned fact leaves an extremely difficult choice to the Government, should it sacrifice long-term growth to take care of what is hopefully a short term problem? Or should it ignore the short term problem, implement policies designed to promote long-term growth in the hope that increase in supply at least in the long run will ensure that there is no aggregate excess demand. Clearly this is a very difficult trade-off and it does not make sense to take a decision without detailed qualitative and quantitative analysis.

If the chronic Indian problems of poverty, inequality and unemployment are effectively handled or attended in this new economic policy of LPG, then can be a significant increase in the market extent and the business environment can improve considerably.

CRITICAL VIEW POINTS:

In order to control inflation we cannot afford to slow down the growth rate because it depicts the economic strength of the country. Therefore the government must ensure that the entire 100% of the population is benefited by this growth.

To achieve this stage is not an easy task, first the extreme underemployment which is prevailing in the agricultural sector has to be drastically reduced.

There must be a shift in the population from the rural to urban, here shifting does not mean transferring the population physically from villages to cities. Shifting should be done by improving the infrastructure in the villages, installation of industries and improving there standard of living by providing quality free education to all. In short, provide all urban amenities in rural India too. The Government should try and reduce its freebies and subsidies and should increase capital expenditure for the rural development which will pave the way for long term growth with stability which will automatically improve the disposable income and standard of living of the rural population.

If the above mentioned objectives and measures are properly implemented, then with our population Indian economy will be the most admired, strong economy in the world.


Ø India’s Economy is in the upward swing in automobile, software, electronic and electrical sector, Banking, Insurance and other Infrastructure related sectors.
Ø Often India’s economy is compared with China in terms of FDI Inflow, currency compatibility, and Growth in terms of GDP. While India follow a U shaped economy in the sense it had witnessed a slow down in the economical growth but now it is experiencing an upward trend in all spheres of activity. China’s economy is a V shaped curve where in it started its economical revamping exercise as early in 80’s and it is growing faster but not in terms of qualitative measurements. This upward and downward swing in both the economies is due to the confidence level in the overall GDP growth, per capita income, control of Inflation and the most preferred nations for FDI Investments.
Ø Inflation is a wild animal in which it needs to be fed with the proper recipes when it is needed. Since corrective measures cannot be done in a hurried fashion if Inflation is going beyond control.
Ø The policy measures introduced by India have further created a debilitating stage which is the cause for the Inflationary trends since 2006.
Ø Of the three segments in the economy i.e. have lots, have-nots and haves, the have-nots and the haves continue to bear the major burden of the inflationary situation.
Ø The rising trend in the Real Estate prices, increase in the interest rates in particular for housing loans, increase in petroleum prices and in commodity prices, the increase in CRR and Repo rates by RBI have all shakened the common man ( i.e. 780 million – constitute haves and have-nots).
Ø The lopsided growth in IT and ITES have created a saving – expenditure imbalance and hence the economy is coined as Economical Divide, which psychologists name it as Human Divide.

The post liberalization has created a positive atmosphere for a steady growth in certain sectors and a disturbing growth in certain other sectors. While the growth in education sector is 3.5%, in higher education it is less than 2% in insurance sector it is 2%, but the growth in Infrastructure and in real estate construction is 60 to 70%, which is a phenomenal achievement, this will develop 269 industrial sectors. This will facilitate and enhance the purchasing power and disposable income of individuals working in the sector, and as a corollary savings, investment and expenditure in consumer households will increase. At this juncture a possible solution has to emerge from the economists, environmentalists, and academia – industry for finding out workable feasible solution for at least containing the Inflation to the tune of 4%. Whether it is a Midsummer Nights’ Dream, or a Comedy of Errors has to be decided not by the technocrats and the techno-econocrats but by the democrats, in concrete terms by the common man, to be or not to be is an unanswered question?


By

S. Hari Balaji
ICFAI Business School (Chandigarh)
Student
Mobile: 09988355311
E-mail id: ibs.hari@gmail.com