Thursday, July 08, 2010

India's inflation problem and the elephant in the room

There's a lot of talk in the Indian media about why inflation should be so high and the general consensus seems to be that last year's poor monsoon is the culprit.

Is there an elephant in the room here that we all refuse to see? I mean, isn’t there a link between the high inflation that we are seeing now (particularly food inflation) and the recent vastly increased outlays on social “welfare” schemes? Is it not best understood as the reverberations from that chest-thumping moment in parliament when finance minister Pranab Mukherjee declared so grandiloquently that for the first time, India's budgeted expenditure would cross Rs.100,000 crores.

Take the example of all that money going down the NREGA drain. This has the immediate effect of injecting a lot of extra purchasing power into the economy without doing much on the output side (neither the short nor the long term). Naturally, inflation follows and this should be a no-brainer. And if you look at the kind of activities financed by the NREGA, they are actually not very far from simply digging trenches only to have it filled up the next day (all in the name of “employment generation”).

A while back I read a news story purportedly about the “success” being achieved by the NREGA. It mentioned that farmers in Punjab were facing a shortage of labour to harvest their crops because of a slow-down in the hordes of seasonal migrants from U.P. and Bihar that earlier used to turn up for this kind of work. And this was because the NREGA, by providing them work near their villages, had made the trip to Punjab less worthwhile. Yes, this is heart-warming stuff.

Unfortunately, economics has very little time for warm hearts. What is actually happening is this. Instead of doing economically productive work (harvesting crops), labour is being diverted into unproductive work (digging trenches), and getting paid in the bargain. It pushes up the costs for Punjab farmers, which invariably finds its way to the government in the form of higher minimum support prices, and it does nothing to increase output in the economy which might otherwise have absorbed the extra purchasing power created. Costs have gone up, output is stagnant, and at the same time, people have more money in their hands.

And this is just so much about what has happened. What is in store for us is perhaps even worse. Wait till the Food Security Bill and its promise of food grains at Rs.2 (or Rs.3) a kilo becomes law. The government will then necessarily have to acquire a lot more rice and wheat from the market for supply to the “poor”. A lot of it will get pilfered or wasted in the logistics and in the hands of the end-user (knowing what happens to things given away for free), and importantly, it will also cut down on the supply available in the open market for purchase by our “aam aadmi”. At this point, it is simple demand and supply.

Anyone who has a doubt about what I have just said should feel free to look up the inflation rate in Venezuela where our Comrade Chavez has lately been into a lot of social “welfare”.

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