What kind of inflation would you like?

Few people would want to be in Pranab Mukherjee’s shoes this year. Whether he likes it or not, the country is poised on the brink of an economic volcano where no matter what he does, inflation will result. When a country keeps putting off structural reforms indefinitely due to political pusillanimity, it will pay the price someday.

That day has arrived. The country has seen very little economic reform since the NDA government under Atal Bihari Vajpayee started selling public sector assets (Balco, VSNL, etc) in the early part of the decade. The NDA also began the process of decontrolling oil prices, but when the 2004 elections loomed, it chickened out.

Under the UPA, we have had one big, botched privatisation — that
of Mumbai and Delhi airports. And that’s it. Important sectors that should have been opened up (or opened up further) — telecom, insurance, banking, media, retail — have been left where they were.

Fuel prices have been bottled up and the oil companies are bleeding as a result. Nitrogenous fertiliser prices have been held for nearly a decade, and the taxpayer is picking up all the bills. The farmer isn’t cheering either.

Cheap urea has made him a fertiliser-addict, and his land is being degraded. As for agriculture, we haven’t even begun looking at it, caught up as we are in esoteric debates on whether Bt brinjal is good for us or not.

What now?
The answer, unfortunately, is that costs will start pushing prices hard, and they will continue doing so unless we have real reforms.
Prices rise for three basic reasons - too much demand, too little supply, or lack of reform that constrains either demand or supply, or both. A flashback on the reforms we have already implemented is indicative.

Telecom was opened up, and we have the cheapest tariffs in the world. Insurance was opened up, and the customer now has an entire array of products to choose from. The entry of private players in banking has brought cheap internet and ATM banking for everyone.

Plane fares are firming up because airline companies are bleeding, but we have benefited hugely from the low-fare bonanza in the initial years of open-skies. QED: Reforms and competition improve systemic efficiencies and usually lower prices.

The current bout of inflation relates to all the three causal factors: demand, supply, and lack of reforms. Especially the last. This is why it is pertinent to ask what kind of inflation do we want? Cost-push through reforms, or a generalised one brought on by excessive government spending?

The bucketloads of money being thrown at the poor and rural (NREGA, farm debt writeoffs) has pushed up demand for every wage-good, specially food.

On the supply side, there have been no agricultural reforms for decades — and so food output is not growing as fast as demand. As long as we keep improving the lot of the aam aadmi without giving farm productivity a boost, food prices are going to stay high.

Not only that, every element that goes into food prices is also in desperate need for reform. Fertilisers, water, diesel and power — all these are subsidised for farmers. The minute we start to at least recover the cost of producing these inputs, food prices will get another fillip.

Oil prices are subsidised for everyone — truckers (diesel), households (cooking gas), and the poor (kerosene). Once again, there is a limit to subsidies. The minute we start freeing the prices of petro-fuels, we are going to have another cost-push.

Then we have the stimulus package to unwind. In the last financial year, two finance ministers were very generous in reducing excise and service taxes across-the-board in order to exempt us from the global recession.

These measures have stoked inflation instead, and the tax cuts now have to be clawed back. When the stimulus measures are curtailed or withdrawn, consumers will have to pay more. So, more
inflation lies ahead.

The administered costs of oil, fertiliser and power have been pressed down so hard that they are waiting to spring back like a jack-in-the-box.

If they are not freed, the government will end up picking the tab. In
the last Budget, Pranab Mukherjee found himself over Rs 5,00,000 crore short (his faulty budget arithmetic, however, put the fiscal deficit at just over Rs 4,00,000 crore), indicating that there are limits to how much he can keep subsidising us.

In the short-term, he can’t do much to keep down prices, since
reforms mean freeing prices and letting them rise. But in the long term, reforms will allow the markets to impose their own price discipline.

If he doesn’t do this, his budget deficit will keep bloating, and oceans of printed money will be sloshing about in the economy, building inflationary potential.

Mukherjee thus has two choices: he can reform administered prices and put up with a one-time price eruption; alternatively, he can keep subsidising everyone indefinitely and let excess money stoke widespread inflation. It will come back and bite the aam aadmi in the butt.