A tightening of monetary policy when the economy is beginning to get out of its downturn and credit growth and investment demand are anaemic will surely have an adverse effect on investment demand even if banks maintain lending rates. The likely rising of interest rates due to this tightening of monetary policy will not only dampen investment intentions but also attract more capital inflows. This will exert upward pressure on the rupee’s exchange rate, adversely affecting exports, which are just recovering from a 12 month long decline. Could all this have been avoided?
The answer is yes. We could have avoided putting the entire onus of countering inflation on monetary policy by taking measures to tackle food inflation that has been raging in the double digits for several months. We have instead the unseemly spectacle of blame and counter-blame between the Union and state governments and within the Union government itself. The agriculture ministry is blamed for mishandling the situation and the latter passes the buck back by stating that the entire cabinet is responsible for tackling price rise. This is rather disingenuous because it is the responsibility of the agriculture minister to take the necessary initiatives and exert pressure on his cabinet colleagues to move in the desired direction. Everyone seems to have simply resigned to hoping for improvement in the rabi harvest to bring down food prices. Such policy paralysis does not inspire confidence.
The durable and effective solution to the phenomenon of rising food prices will come from raising agriculture yields, which have been stagnating for decades, and improving productivity levels by pumping more investment into rural infrastructure and introducing new technology. There is a growing gap between rising per capita income and declining per capita availability of food products. This gap can be filled by raising domestic output, facilitating movement of agricultural produce across state borders and liberalising agricultural imports and exports. These will allow private traders to respond in a timely and effective manner to tackle emerging shortages and prevent price increases. But these are medium- to long-term measures.
More immediately, we must start by taking a clear view on factors that are responsible for rising food prices. Demand has picked up with higher purchasing power in the hands of the poor through the National Rural Employment Guarantee Act and other social security expenditures and the expanding middle classes. Supply shortages have emerged due to the drought and stagnating yields, and these are exacerbated by speculative activity fuelled by excessive liquidity and which also feeds on itself. The only possible remedy appears to be import of relatively large quantities of lentils, cereals, sugar and edible oils, that are usually the main culprits. These imports can be supplied to the open market at lower than currently prevailing prices. The government has to announce its firm intention that it will persist with such imports even if that involves a measure of subsidy, as the landed prices of imports could well be higher than prices at which these additional supplies can be introduced in the domestic market. It should also announce that it will continue with these subsidised open market operations until food prices come down and inflationary expectations have been reversed.
Such an ‘inflation-countering subsidy’ is justified as a vital input for maintaining growth with macroeconomic stability. At the same time, a road map for restoring fiscal balances over the next three to five years will signal that both fiscal and monetary policies are being directed to suck out excess liquidity from the system. That will help dampen speculative activity.
What could possibly be the problem with such a move? The most pernicious argument I have heard is that the government should allow traders to make extra profits in times of relative scarcity, when in times of relative abundance they are forced to incur losses because the government does not lift export bans in time and stops procurement activities. It is time we took an urgent and serious look at liberating Indian agriculture from the extensive government controls that are in place ostensibly to protect our small and marginal farmers. I am convinced that with limited, well-targeted and market-based government interventions, both small farmers and consumers will benefit from a greater integration of Indian agriculture with global markets and access to foreign technology and capital flows.
his essay is adapted from an opinion piece first published here in the Mint.
Dr Rajiv Kumar is Director of the Indian Council for Research on International Economic Relations.