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Inflation is inevitable, get over it

Probir Roy
Probir RoyApr 04, 2016 | 20:10

Inflation is inevitable, get over it

We celebrate lower inflation like an event. As someone put it, it's just like 66,000 people celebrating the West Indies win at the Eden Gardens. Most of them don't even know where the Caribbean is!

It is becoming apparent (if not inevitable) that inflation targeting is going to be trying as we move towards 2019 and beyond. The RBI target of four per cent could be a short-term chimera. Perhaps one could be sanguine about the glide path of inflation by 2018.

If one were a rocket scientist, one would worry about the arc of the flight, not glide path - when will it reach its apogee before settling into a steady state.

The boost of fiscal spending and possibly second-order effects on income will put pressure on inelastic supply side elements. It will lead to transmission into Consumer Price Index (CPI), as the economic release valve.

At best it is a short-term achievement. But it is a deserved one too. In the longer term, the band of two per cent up/down would be breached even without any exogenous supply shock.

Here is why.

Say if farm incomes, I mean "rural" by that, go up 2 x. One does not know the mechanism. Perhaps via Minimum Support Price (MSP) or other off budgetary means (certainly not play of market forces).

However, one doesn't see rural productivity going up commensurately. So more income (wages) will be chasing fewer available goods and food items (coarse grain, pulses, vegetables, etc). And perhaps also high-value food items (dairy, proteins, etc).

This spillover will also affect demand for non-food items assuming Engel's law has a play. And we know Engel's curve has a log-linear relationship across time and societies. I dont want to bring in any orthodoxy or hubris into this. But at some level it is a vindication of the Nurkse-Reddy-Vakil model.

But as they say, the more things change, the more they remain the same.

On the other hand, NREGA and other income/wage schemes for the poor and rural population (LPG, pension, medical, accident, life crop insurance, JDY overdrafts, loans, etc) will add/free up more rural income. This will manifest itself by chasing food, non-food and aspirational items.

Whilst this will give a fillip to overall aggregate demand, the aggregate supply will be fairly unresponsive due to inherent lags and legacy capacity issues. These will feed into wages and creep into headline and core inflation.

Supply side infirmities are a bane which no amount of monetary policy or fiscal management can remedy.

Or can it?

Sure, stock of improved infra (capital and social overhead goods) will help mitigate supply bottlenecking. But production of goods is key. Services are flexible and relatively responsive to emergent market forces. But the former can be remedied by economic incentives, signals and play of market forces. And not by government fiat or headlines in press.

Even with the "fuzzy" 2016-17 Central Budget logic, the other factors would necessitate a data-driven and calibrated approach. Probably a Faustian understanding has been reached for a RBI rate cut. Maybe even upto another 50 bps.

Else, there is little wiggle room for a cut till the monsoons. I would be seriously preparing for inflation, as and when the economy picks up. As it probably will, before falling back to the Hindutva growth rate of five per cent.

In short, the nominal economy will once again run ahead of the real one. And you know what happens then.

Last updated: April 04, 2016 | 20:10
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