The Central Statistical Organization has given everyone a very pleasant surprise by releasing figures which show that the country’s gross domestic product during the quarter, July-September, grew at 7.9 per cent over the corresponding period last year. This surpasses everyone’s expectations by a comfortable margin, with the average prediction being close to 6 per cent. The fact that expectations were very modest is not surprising at all because most major economies are still feeling the after-effects of the global recession. So, the experience of the Indian economy certainly stands out in comparison.
Of course, some part of the growth in GDP is illusory: it has been generated more by the way in which GDP is measured. In particular, the salaries paid to government employees are counted as part of the “community, social and personal” services. Since government employees were paid an instalment of their arrear salaries during this period, this sector exhibits a very high rate of growth. Unfortunately, as we all know, higher government salaries are typically not associated with any increase either in the volume or quality of services received by us.
However, there has also been a most welcome acceleration in the ‘real’ sectors of the economy, with manufacturing as well as mining and quarrying recording very satisfactory rates of growth. Since the global economy is yet to recover from the slump, the Indian export performance has not been particularly bright. Clearly, it is domestic demand that has triggered off a process of recovery in the Indian manufacturing sector.
So, the government can claim with justifiable pride that its expansionary policies have been largely responsible for the speed with which the economy seems to have come out of the downturn. It did set in place a fiscal stimulus programme with increased expenditure in the social sectors in particular. Some tax concessions were also given. The Reserve Bank of India also pitched in, reduced interest rates steeply and also put in place measures to ensure an adequate supply of credit. It helped that the domestic banking sector as a whole remained virtually untouched by the turmoil in the global financial sector. This ensured that banks were not reluctant to extend credit.
However, the government now has to contend with a new set of contentious issues. Over the last couple of months, there has been a steep rise in prices. What is particularly worrying is that prices of staple items of food have gone through the roof. The fight against inflation must become the principal focus of government policy in the immediate future.
Since the economy has been restored to a moderate degree of health, the need for the fiscal stimulus programme is no longer as acute as it was even a few months ago. Similarly, the RBI can perhaps afford to raise interest rates and also move, at least slightly, towards a tighter monetary regime. Not surprisingly, some economists believe that the RBI will soon raise the cash reserve ratio in order to restrict the increase in the flow of credit. These are, of course, classic and conventional measures to control inflation. They are designed to choke off aggregate demand. To the extent that prices rise when demand exceeds supply, the logic underlying these anti-inflationary policies is quite transparent.
Unfortunately, the design of appropriate policies is not always this easy. For instance, the economy is still in the initial stages of recovery, and it may be imprudent to change the policies too suddenly from a growth-inducing regime to one that is primarily an anti-inflationary regime. Some degree of fine tuning is clearly important, for there is the obvious danger that an excessive degree of contractionary policies may again push the economy back into deep slumber. Since that is the last thing that the government wants, both the finance ministry and the RBI need to proceed rather cautiously along this route.
But there is another far more serious reason why exclusive reliance on contractionary policies is undesirable. Surely, the finance minister does not want to advice the representative housewife to curtail her family’s consumption of rice, potatoes and other vegetables because lower demand for these commodities would bring down prices?
In other words, when prices of basic food items are rising, the appropriate policy response must surely be to tackle the problem from the supply side. Of course, it may sometimes be possible that an increase in the rate of interest — which is typically viewed as an instrument of tight money policy — may help bring down food prices by raising the cost of hoarding and hence forcing traders to release larger stocks on the market. But the emphasis must be on ways of augmenting supply.
The government’s short-term policy options are somewhat limited because it is not feasible to increase production instantaneously. That is why the current bout of inflation should have been anticipated and the government should have taken appropriate steps much earlier. The debate about whether the country should import rice illustrates the ham-handed manner in which the government has handled the situation. Some ministers have said that the government would not hesitate to import rice if prices spiral out of control, while others have asserted that the country’s buffer stock is more than adequate. Finally, the empowered group of ministers have met recently and decided that there is no immediate need to import rice.
But, the current stock of rice available with the government is reported to be over 15 million tonnes — this is a very large amount and quite adequate to deal with sudden emergencies. Why has the government not been releasing some of this stock in instalments? The increased supply of rice would have helped to cool off the market price. Equally important, it would have been a powerful signal of the government’s intention to act decisively. This would have prevented, or at least reduced, the speculative hoarding of rice by traders since they would no longer be confident of future prices being higher. For similar reasons, it would have made the task of procurement agencies easier. At any rate, given the thinness of the international market for rice, prolonged discussions about whether India should import rice or not only serve to drive up the price in the international markets to stratospheric levels.
Perhaps, the government was so preoccupied with the global recession and its effects on the domestic economy that it neglected all other problem areas. But, now that the economy seems to have been nursed back to health in so far as GDP growth rate is concerned, one can only hope that the government will act decisively on other battlefields.