At the back of this success is the strength of the US monetary policy that helped keep prices stable, despite the massive pumping in of trillions of dollars.
In contrast, here in India we failed to tackle inflation during the very same period from 2008-13. Throughout this period, inflation, rather than economic growth, raged in double digits. And there can be no denying that the Central government and the Reserve Bank are at fault. The Congress was smashed at the hustings, thanks substantially to the failure of the UPA II government to tackle inflation.
Pervasive increase in prices
The middle class has been ravaged by the uncontrolled increase in the prices of a vast range of articles of common consumption, especially fruits, vegetables and other food items. In Chennai the price of a banana has shot up from around Rs 2 a piece to Rs 5 plus today, rice from Rs 20/kg to close to Rs 50/kg, gingelly oil price to Rs 250… Political parties should only be too aware of the impact of high prices of onions. Yet, the government failed to attend even to this before the polls.
The increase is pervasive. The prices of cement, steel, even river sand and bricks have all shot through the roof. In a like situation in 1991, the government tackled it from the supply side. It increased the supply of commodities to bring prices down. The game of volume was at play. This time around, it won’t work. For it to work the price rise should be restricted to select commodities and not to the entire basket of commodities. Worse still, there was the inability to step up supplies of coal and gas, thanks in the main to corruption.
In mature economies, the executive and the central bank work in tandem to tackle such issues. The executive sets up the fiscal policy, expands the supply of commodities and tackles unethical practices like hoarding and price rigging. The Central bank, entrusted with the responsibility for monetary policy, attends to the issue by controlling money supply and interest rates. In India, sadly, the UPA II administration failed on both counts. The result was inflation raging like a bull throughout the past four years. The executive, for its part, went on a spree of expanding subsidies and freebies without concern for the massive fiscal deficits, slowdown of investments, falling growth and a depreciating rupee.
Babes in the wood
What could the Reserve Bank have done to address the issue? There was a facile attempt to explain away the conflicting roles of growth and control of prices. RBI Governors Y V Reddy and his successor D Subbarao resorted to control of money supply and increasing interest rates to contain inflation. Especially during the regime of Subbarao, there were interest rate hikes almost every quarter. Understandably, these had the effect of constricting credit for development on affordable terms.
The easy route was to resort to increased levels of financing deficits by printing notes. Monetary economist T B Kapali points to the massive bloating of the balance sheet of the Reserve Bank: “from Rs 3 lakh crore in 1999-2000, it had increased in 2012-13 to Rs 25 lakh crore. This huge increase was the result of the profligacy in creating fiat money and thus printing away the budget deficits.”
Kapali points to three major issues that have remained unresolved:
• Institutional weaknesses where no clear mandate / policy objective is given to the RBI and the central bank is treated as an extended financing arm of government
• Weak overall tax take of the government
• High spending commitments
These three combined together tempt the political establishment to use the Central Bank to plug its budget gaps. The historical cross-country experience which the three conditions obtain is of serious and periodical inflation crisis. That’s what India is experiencing now.
Sadly, successive policymakers in the finance ministry and RBI Governors have failed to address these structural weaknesses. There is no indication that these will be addressed with firmness in the immediate future. The outlook for the short term thus appears extremely depressing. There is hope on the new Governor Raghuram G Rajan making bold to attend to this. But only time can tell on the leeway he has.