Inflation in India Growth Story

The events started unfolding from last Friday February 9, 2007 when Indian government came up with weekly inflation numbers. It came out to be whopping 6.58% over the same week last year. This is highest for last two years. At the same time Standard and Poor’s (S&P) upgraded India to Investment grade. The estimated GDP growth for financial year 2006-07 is also upgraded to 9.2%. So we are posting a nominal growth of about 16% and this all in spite of the Repo rate being increased to 7.5%, Reverse Repo rate to 6% & CRR (Cash Reserve Ratio) to 6% (on February 13, 2007).

All these numbers give a clear indication that the economy is overheating. There is excessive demand for loans, particularly corporate loans and home loans. But the banks are coming under liquidity pressure as there are not enough Fixed Deposits to balance these loans. The government is trying to curb this boom but obviously it is having no effect as far as slowdown is considered.

Let us see why the corrective measures are not working even though they are all short term measures. Ostensibly this inflation is due to commodity prices going up including essential commodities like wheat-paddy and pulses, probably because of erratic monsoon we had last two years and also the commodity trading in cash and derivatives in MCX (Multi Commodity Exchange). So government is taking all the corrective measures looking at this sector. But what prima facie seems to be the truth, is not necessarily the whole truth. There is huge share of services in pushing the inflation up so high. The service sector forms 52% of total GDP of India. Increase in prices of services is going to have greater impact on the prices. The services are highly intangible. There is no pricing commission working for keeping the prices of services down. Adding to that our respected Finance Minister Mr. P. Chidambaram has brought plethora of services under the Service Tax. This helped the service sector to increase their prices further. This is to such an extent when a service was tax-free it was Rs. 100/- but now after taking it under 12.5% Service Tax it is quoted at Rs. 150/- inclusive of taxes. So inflation is about 30% in sevices.

They can afford to increase the prices so high because of our IT generation who are earning hefty amounts and have lost a sense of prices they are paying. Same is the case of real estate. The builders and brokers here are asking for Rs. 5000/- per sq. feet like asking for a glass of water. There is no pricing commission working over real estate also. Clearly the prices have gone way beyond sense in the metros and there no way other than facing a pricing meltdown, the way it happened in California, US. And adding to that in today’s scenario a person earning above Rs. 2.5 lakh p.a. is taxed at 33.66%. In this situation a person earning Rs. 3 lakh p.a. cannot give a proper shelter and feed a family of 4 properly in a metro.

The growth story is all right, but when it stops making sense in prices you should open your mouth and say, “it’s ridiculous!” and this is not all with the economy. The government has decided to let the rupee appreciate to curb the inflation. But this rupee appreciation is directly going to affect the export oriented businesses on profit margins. Also we are carrying a hefty 4+% of GDP current account deficit and about 2% of GDP fiscal deficit. With export hurting and imports getting cheaper, this gap will further widen and eventually it will make India an unattractive investment destination. So while making short term corrective actions we have to take into account long term implications of it. If we let this economy overheat, it eventually will end up in recession (even though it will be a short one). And if we have a recession in a period of 5 years since 2002-03 then again it will show a weak character of economy and lack of control of government over the economy. And all this when highly respected economists like our Prime Minister Mr. Man Mohan Singh, our Finance Minister Mr. P. Chidambaram and our RBI Governor Mr. Y. V. Reddy in the top spots. If they are not in the position to keep a check on it, then it is sure that our economy will never be in our control.

So, along with the current short term measures some long term measures are also necessary to avoid occurrence of such events in future. But now some serious thoughts have to be put in and some drastic measures are to be taken. If US economy can manage a soft landing after overheating then we have every reason to believe that we can, too.

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