If only inflation woes could be washed away by the summer monsoon. Instead, India is girding itself for a “new normal” of inflation running at 6 to 8 percent, from the roughly 5 percent considered acceptable by policymakers in recent years, as a racing economy exacerbates structural bottlenecks. India’s growth-obsessed government appears resigned to elevated inflation, which has consistently outrun its forecasts and become a distracting liability for the ruling Congress party. Both consumer and wholesale price indices are in double-digits, making Indian inflation the highest among large economies. “What India will go into is this period when inflation remains elevated and sticky,” said Jahangir Aziz, chief India economist at JPMorgan, who expects inflation of 7.5 to 8 percent over the next 18 to 24 months.
While the government is taking steps to address long-standing infrastructure bottlenecks and stagnant farm output, the slow pace of implementation means investment and reforms will struggle to keep up with rising demand and rampant urbanisation. “The problem is the agricultural sector needs productivity growth, cities need better infrastructure, the country in general needs better infrastructure to take the pressure off inflation,” said Sanjay Mathur, head of research and strategy for non-Japan Asia at Royal Bank of Scotland in Singapore. The danger of stubbornly rising prices is that inflationary expectations can feed on themselves, fuelling asset price bubbles and eroding export competitiveness. That in turn can force the central bank to tighten monetary policy more aggressively than it would otherwise do, at the risk of choking off growth. In any case, it removes the margin for error in setting monetary policy.
In India, the policy response is complicated by the fact that food inflation, a key driver of higher prices, is beyond the scope of monetary policy. Inflation can also widen the wealth gap in a country where nearly 40 percent of the 1.2 billion population lives on less than $1.25 a day but the ranks of dollar millionaires have grown at 11 percent a year over the past decade, to 115,000. Already, high prices have triggered protests and the government’s late June decision to lift fuel prices led to a one-day nationwide strike called by the opposition. Without bolder efforts to improve farm output, the government will be forced to rely more on imports and subsidies to the “aam admi”, or common man, that makes up its voter base, adding to a stressed fiscal position and leaving less cash available for much needed investment.
India is on track to grow at 8.5 percent this year, behind only China among major economies. New Delhi, which must ensure that the “demographic dividend” of a surging working age population does not become a time bomb of underemployed masses, has set a goal of double-digit growth in coming years. China’s export-fuelled economy has managed sustaining such growth without overheating, but India is not China. “China’s problem is so different because their growth model hinges on capacity creation, whether it’s infrastructure, whether it’s manufacturing,” RBS’ Mathur said. “India is quite the opposite: it’s all about fiscal dominance, ineffeciencies in the infrastructure sector, in the agricultural sector, and a growth pattern that doesn’t apply to the whole country,” he said. Finance Minister Pranab Mukherjee has made clear that he can live with higher inflation if it is the price for strong economic growth. “If I want to compromise with growth rate of 5 percent, or 5.5 percent, if I want to compromise with my export growth, if I want to do that, I can surely control the inflation,” Mukherjee said in a parliamentary debate on Wednesday. “Inflation can be drastically cut but that will not generate employment,” he said.
BEYOND THE MONSOON
This summer’s ample rains will offer some respite, cooling food prices, while the base effect after a year of higher costs will soon kick-in, pushing inflation down to single-digits. Interest rate increases, meanwhile, help defer demand for big ticket items like motorcycles and TV sets and encourages saving. Monetary policy, however, is helpless in the face of a growing mismatch between rising demand for food — in part a result of social programmes that have increased consumption by the poor — and stagnant agricultural output. Foodgrain production has risen less than 1 percent a year in the past decade even as per capita incomes have roughly doubled. Crop yields in India are one-half to one-third levels in China and the West, and poor supply chains are infamous for a spoilage rate of 40 percent for fresh produce. Thus far, the government has failed to overcome opposition to initiatives such as allowing genetically modified food crops and foreign direct investment in retail, and only recently shifted subsidies to encourage use of more productive fertilisers. “With rising population and overall growth of the economy, the country’s food demand is likely to rise at much faster rate than the population increase. Food inflation will continue to be a major concern,” said S. Raghuraman, an analyst with Agriwatch.