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V.K.Madhav Mohan - The Leader : Mentoring Services, Mentoring Workshops, Mentoring products- Articles / Audio / Video/ Posters, Lectures |
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Too much money around Published in The Week, December,4th, 1994 The economy is growing, external balances are healthy, industrial production has rebounded and food grains output has scaled yet another peak. So why is there still that feeling of disquiet? The problem is all parameters but one are in the green zone. And it is the rising trend of this one factor-inflation-that has set the cat amongst the pigeons. Today, double-digit inflation stalks the economy. In fact, following the financial ineptitude of previous decades, runway inflation was always on the cards. It is probably a tribute to the skill of the present economic managers that the prices have been prevented from spiraling out of the 8 to 10 per cent band despite the strong pressure for it to burst through the 10 per cent barrier. The major contributor to this pressure is the surge in broad money supply, which on an annualized basis has increased by about 20 per cent (as of October 94). The swelling of the forex reserves kitty has played a major part in the expansion of money supply. For instance, net foreign assets grew by Rs 15,596 crores in 1994-95 (upto 30-9-94) against a growth of only Rs. 3,933 crores in the comparable period of the previous year. The mandarins of North Block are thus faced with a rather tricky dilemma: how to build forex reserves without intensifying the already worrisome liquidity overhang. One of the keys to the control of inflation lies in the hands of the government: reduction of the budget deficit. For this to be achieved beyond any cosmetic pruning of expenditure requires real political will. Today the need is not so much to cut government expenditure in the next six months as it is to embark upon a long-term program to downsize government itself. A structural adjustment of the size and scope of government is of vital import to not only the economy as a whole but also to long-term stability on the inflation front. This is why a concrete privatization policy brooks no delay. For an economy that is still so dependent on agriculture, any for an economy that is till so dependent on agriculture, any increase in the production of food grains in particular must come as a welcome relief. But even though food grains output has surpassed last year's level and the godowns are bursting at the seams with a buffer stock of over 40 million tonnes, prices are recalcitrant. For millions of people, food grains are becoming costlier and costlier. One of the immediate tasks is to augment storage capacity so that we can cope with the increasingly higher plateaus in our food grains production. This will improve our ability to match supply with demand and thereby mitigate the price rises. Investment in food storage and processing must therefore be encouraged by making it profitable. No discussion of inflation can be complete without looking at interest rates. Our economy has still a long way to go before a direct and strong casual relationship can be established between interest rates and inflation: until our transition to a free market economy is complete the interest-inflation link will continue to operate via the central bank's administrative diktats on deposit-interest ceilings.Nevertheless, the recent removal of interest ceiling on loans above Rs. 2 lakhs is a huge step towards interest rate deregulation. Restrictions on deposit rates remain for the time being but dramatic changes are in the offing. Given the fact that deposit rates are unchanged and that inflation is around 9 per cent, depositors are now earning extremely low real rates of return. If inflation climbs any higher they will suffer from the effects of a negative real rate of return. The savings of the household sector account for about 80 per cent of the total savings in India with savings rate an astounding 23 per cent. There is chance of it going any higher. But savers in India now have much greater choices in the deployment of their savings. So the threat of erosion by inflation may combine with the already poor service of most banks to shift large chunks of savings from the banks and into the capital markets. The banks therefore have much more to worry about than just non-performing assets. Soon we will be more fully integrated with the global economy and therefore subject to far greater competition and freer flow of funds. Interest rates, exchange rates and inflation will all be strongly interconnected. Just as the dollar and deutsche mark are closely related via the real interest rates, so too will the rupee be linked with other major currencies. With such an integration, we will be susceptible to inflation-infection from the other economies. In such a scenario, the availability of information will determine economic performance. This is an area of weakness. Our data reporting methods and discipline will have to improve by leaps and bounds if we are to operate successfully in the global economy.
Ultimately, the only way to protect ourselves from inflation is to strive continuously for higher productivity. Only then can we ensure that the real rate of return on investment remains positive and attractive. If the growth in productivity is higher than the rate of inflation we do not have to worry. But if inflation noses ahead of the growth in productivity, living standards will crash.
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